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  • 1. Gripping IFRS The Pillars of Accounting Chapter 1 The Pillars of AccountingReference: The Framework and IAS 1 (revised September 2007)Contents: Page 1. Introduction 4 1.1 Accounting, science and languages 4 1.2 The problem 4 1.3 The International Harmonisation Project 4 1.3.1 More about the Standards and their Interpretations 5 1.3.1.1 The standards 5 1.3.1.2 The interpretations of the standards 5 1.3.1.3 How the standards and interpretations are developed 5 1.4 The International Improvements Project 7 1.5 Due process and transparency 7 2. IFRS versus GAAP 7 2.1 Overview 7 2.2 Compliance with IFRS 7 3. The Pillars 8 3.1 The Framework 8 3.2 IAS 1: Presentation of financial statements 8 4. The Framework 9 4.1 The objectives of financial statements 9 4.2 Underlying assumptions 9 4.3 Qualitative characteristics 9 4.3.1 Understandability 9 4.3.2 Relevance 9 4.3.3 Reliability 10 4.3.3.1 Faithful representation 10 4.3.3.2 Substance over form 10 4.3.3.3 Neutrality 10 4.3.3.4 Prudence 11 4.3.3.5 Completeness 11 4.3.4 Comparability 11 4.3.5 Constraints to relevance and reliability 11 4.4 Elements 12 4.4.1 Asset 12 4.4.2 Liability 12 4.4.3 Equity 12 4.4.4 Income 12 4.4.5 Expense 12 4.5 Recognition 12 4.6 Measurement 13 4.7 When the element is not recognised 14 4.8 Recognition versus disclosure 14 4.9 Answering discussion type questions 14 4.10 Some examples 15 Example 1: Benefits earned over more than 1 period: expense/ asset? 15 Example 2: An inflow – income or liability? 16 Example 3: Staff costs – an asset? 17 1 Chapter 1
  • 2. Gripping IFRS The Pillars of AccountingContents continued … Page 5. IAS 1: Presentation of financial statements: an overview 18 5.1 Overview 18 5.2 Scope 18 5.3 Objective of IAS 1 19 5.4 Objective of financial statements 19 5.5 Definitions 19 5.6 Complete set of financial statements 20 6. IAS 1: Presentation of financial statements: general features 20 6.1 Overview 20 6.2 Fair presentation and compliance with IFRS 20 6.2.1 Achieving fair presentation 20 6.2.2 Compliance with standards of IFRS 21 6.2.3 Departure from IFRS 21 6.2.3.1 When departure from IFRS is required and allowed 21 6.2.3.2 When departure from IFRS is required but not allowed 22 6.3 Going concern 22 6.3.1 Financial statement preparation 22 6.3.2 Managements’ responsibility 22 6.3.3 If there is significant doubt 22 6.3.4 Disclosure required where the going concern basis is not used 22 6.4 Accrual basis of accounting 22 6.5 Materiality and aggregation 23 6.5.1 Accountancy involves a process of logical summarisation 23 6.5.2 Deciding whether an item is material and needs to be segregated 24 Example 4: Items with different functions 24 Example 5: Items with different natures, but immaterial size 24 Example 6: Items that are material in size, but not in nature or 25 function. 6.5.3 What to do with immaterial items 25 6.6 Offsetting 25 Example 7: Sale of a machine (set-off is allowed) 26 Example 8: Sale of a machine (set-off is not allowed) 26 Example 9: Cost of a machine (set-off is required) 26 6.7 Frequency of reporting 27 6.8 Comparative information 27 6.8.1 When there has been no change in presentation 27 6.8.2 When there has been a change in presentation 27 Example 10: Reclassification of assets 28 6.9 Consistency of presentation 29 7. IAS 1: Presentation of financial statements: structure and content 29 7.1 The financial report 29 7.1.1 The financial statements 29 7.1.2 Other statements and reports 29 7.2 Identification issues 30 7.3 The statement of financial position 30 7.3.1 Overview 30 7.3.2 Current versus non-current 30 7.3.3 Assets 31 7.3.3.1 Current assets versus non-current assets 31 7.3.4 Liabilities 31 7.3.4.1 Current liabilities versus non-current liabilities 31 Example 11: Classification of liabilities 32 7.3.4.2 Refinancing of financial liabilities 33 Example 12: Liabilities and refinancing of due payments 33 Example 13: Refinancing of a loan 34 7.3.4.3 Breach of covenants and the effect on liabilities 34 Example 14: Breach of covenants 35 2 Chapter 1
  • 3. Gripping IFRS The Pillars of Accounting Contents continued … Page 7.3.5 Disclosure in the statement of financial position 35 7.3.6 Disclosure in the statement of financial position or the notes 36 7.3.6.1 Sub classifications 36 7.3.6.2 Extra detail 37 7.3.7 A typical statement of financial position 37 7.3.7.1 Overview 37 7.3.7.2 Sample statement of financial position of single entity 38 7.3.7.3 Sample statement of financial position of a group 38 7.4 The statement of comprehensive income 39 7.4.1 Overview 39 7.4.2 Profit or loss 39 7.4.3 Other comprehensive income 40 7.4.4 Expenses 40 7.4.4.1 Overview 40 7.4.4.2 Function method (i.e. use or purpose) 40 7.4.4.3 Nature method 41 7.4.5 One statement or two statements 42 Example 15: two layouts compared 42 7.4.6 Reclassification adjustments 43 Example 16: reclassification adjustments 43 7.4.7 Changes to profit or loss 45 7.4.8 Disclosure: in the statement of comprehensive income 45 7.4.8.1 Disclosure: total comprehensive income 45 7.4.8.2 Disclosure: allocations of total comprehensive income 45 7.4.9 Disclosure: in the statement of comprehensive income or note 46 7.4.10 A typical statement of comprehensive income 46 7.4.10.1 Sample statement of comprehensive income: a single entity 46 7.4.10.2 Sample statement of comprehensive income: a group 47 7.5 The statement of changes in equity 47 7.5.1 Overview 47 7.5.2 Disclosure: in the statement of changes in equity 48 7.5.3 Disclosure: in the statement of changes in equity or the notes 48 7.5.4 A typical statement of changes in equity 49 7.5.4.1 Sample statement of changes in equity: a single entity 49 7.5.4.2 Sample statement of changes in equity: a group 49 7.5.4.3 Exam technique 50 7.6 The statement of cash flows 50 7.6.1 Overview 50 7.7 The notes to the financial statements 51 7.7.1 Overview 51 7.7.2 Structure of the notes 51 7.7.3 Disclosure of accounting policies 51 7.7.3.1 Overview 51 7.7.3.2 Significant and relevant 52 7.7.3.3 Judgements made by management 52 7.7.4 Sources of estimation uncertainty 52 Example 17: Sources of estimation uncertainty 53 7.7.5 Capital management 53 7.7.6 Other disclosure required in the notes 54 8. Summary 55 3 Chapter 1
  • 4. Gripping IFRS The Pillars of Accounting1 Introduction1.1 Accounting, science and languagesBelieve it or not, accounting has much in common with• Chemistry: there are four very basic elements in chemistry (earth, fire, water and air) and in accounting, there are five very basic elements (assets, liabilities, income, expenses and equity); and• Language: this perhaps needs more explanation.Through the ages, very many languages developed; Latin, English, French, Spanish and Zulu,to name but a few. Now English, for instance, is used to communicate information andopinions to other English-speaking people (or to those who are at least able to understand it).Accounting is also a language, but one that is used by accountants to communicate financialinformation and opinions to other accountants (and, of course, to those other interested partieswho are able and willing to try to understand it).In order to communicate effectively in the ‘language of English’ (as in all other languages),there are certain rules to observe when spelling and pronouncing words and when stringingthem together in the right order to make an understandable sentence. When communicatingin our ‘accounting language’, there are similar rules. These rules are set out in detail and arecommonly referred to as statements of generally accepted accounting practice (GAAP).1.2 The problemTechnology, such as phones, faxes, email, jet engines and the internet, has made it possible tocommunicate instantly with people in countries that are thousands of miles away and tophysically visit them within a matter of hours. Much of this globe-shrinking technology hasbeen around for many years now, so communication has already begun between countriesthat, only a few hundred years ago, did not even know of each other’s existence. And thisincludes communication amongst accountants and amongst businesses!The problem is that with so many different languages, communication between differentnationalities can sometimes become almost impossible; picture the scene where an English-speaking New Zealander and a Swahili-speaking East African are trying to have aconversation. Even when speaking the same language, there are some accents that make aconversation between, for instance, an English-speaking American and an English-speakingBriton, just as amusing.Accounting, as a language, is no different. Almost every country has its own accountinglanguage. The language (GAAP) used in one country is often vastly different to that inanother country; so different, in fact, that it is like comparing French with Ndebele. In othercases, however, the differences between two country’s GAAP may be relatively minor that itis similar to comparing Dutch with Afrikaans or Scottish with Irish. These differences,however small, will still result in miscommunication. Whereas miscommunication on streetlevel often leads to tragedies ranging from divorce to war, miscommunication betweenbusinesses often leads to court cases and sometimes even final liquidation of the businesses.1.3 The International Harmonisation ProjectTo avoid this miscommunication, accountants all over the world are joining together todevelop a single global accounting language. This amazing process is referred to as the‘International Harmonisation Project’.Its basic objective is to produce a language that is understandable and of a high quality. Therules of this language are explained in a set of global standards, (referred to as theInternational Financial Reporting Standards or IFRSs). 4 Chapter 1
  • 5. Gripping IFRS The Pillars of AccountingThe process of harmonisation involves discussion amongst standard setters in any countrywishing to be part of the process, during which the reporting processes currently used bythese standard setters (their local statements of GAAP) are considered and then the bestprocesses are selected to constitute or form the basis of the new international standard goingforward.Although most countries (108 participating countries as at 5 November 2007,www.iasplus.com) are already using this single language, there are, as can be expected, a fewcountries who have refused. This project is therefore expected to be a long and politicallyvolatile one, but one which, in the end, will hopefully enable accountants all around the globeto communicate in one language.All countries that adopt the global accounting language, must comply with these rules(IFRSs) in their financial statements for financial periods beginning on or after1 January 2005.1.3.1 More about the Standards and their Interpretations1.3.1.1 The standardsThe idea of a single global accounting language is not new. It all started with theInternational Accounting Standards Committee (IASC) in 1973. Over the years, thiscommittee developed 41 global accounting standards, referred to as International AccountingStandards (IAS). This committee was then replaced by the International AccountingStandards Board (IASB), established in 2001. This new board adopted all 41 IASs andstarted the development of more global accounting standards. So far, the newly created IASBhas developed 8 new standards, referred to as the International Financial Reporting Standards(IFRSs).We now, therefore, have a total of 49 global accounting standards (IFRS):• 41 of which are referenced as IAS 1 – 41 (produced by the old committee) and• 8 of which are referenced as IFRS 1 – 8 (produced by the new board).1.3.1.2 The interpretations of the standardsMany global accounting standards have had to be interpreted. These interpretations aredeveloped when accountants and auditors notify the board of difficulties in understanding andapplying certain parts of a standard. These interpretations were previously developed by acommittee called the Standing Interpretations Committee (SIC). This committee developed 34interpretations (SIC 1 – SIC 34), only 11 of which still stand, with the rest having beengradually withdrawn as a result of the harmonisation process. The interpretations are nowdeveloped by a committee of the new IASB, called the International Financial ReportingInterpretations Committee (IFRIC). To date, 14 new interpretations have been developed bythe IFRIC (IFRIC 1 – IFRIC 14).1.3.1.3 How the standards and interpretations are developedWhen these boards and committees develop the global accounting standards (a term thatrefers to both the standards and their interpretations), it requires members of the IASB and theIFRIC to consult with national standard-setters from all of the participating countries toensure that all of their ideas have been considered. In considering which ideas orcombination of ideas to adopt as the new standard, they use what is referred to as theFramework. This framework sets out the basic objectives, characteristics, concepts,definitions, recognition and measurement criteria relevant for a good set of financialstatements. 5 Chapter 1
  • 6. Gripping IFRS The Pillars of AccountingIn summary, the rules of our global accounting language consist of:• The Framework and• the global accounting standards (IFRS), including both the: - Standards (IASs and IFRSs); and their - Interpretations (SICs and IFRICs).In time, it is expected that all standards will be renumbered and referred to as IFRSs and allinterpretations will be renumbered and referred to as IFRICs. In the meantime, financialstatements that are reported to comply with IFRSs are assumed to comply with all standards(IASs and IFRSs) and their interpretations (SICs and IFRICs).A tabular summary of the above is as follows: IFRS: Previously produced by Now produced by Number of voting members per board/ committee Standards IASC IASB 14 membersInterpretations SIC IFRIC 12 membersThe IASC has been replaced by the IASB, but the IASC Foundation is the organisation uponwhich the IASB and the IFRIC are built. The structure of the team behind the preparation ofthe IFRS and IFRICs is presented below: International Accounting Standards They appoint members to SAC, IASB and There are 22 trustees Committee 22 IFRIC; oversee the process and raise funds Foundation (IASCF) There are approx 40members who meet three They prioritise the IASB’s work, advise the IASB Standards Advisory times a year. SAC +- on their views on major standards projects andoperates in an advisory Council 40 give other advice to both the IASB and the capacity to the IASCF (SAC) trustees and the IASB Develop and pursue the technical agenda, issue There are 12 full-time International interpretations, basis for conclusions withand 2 part-time members. Accounting Standards 14 standards and exposure drafts. They need 9 The IASB reports to the Board votes out of 14 to get standards, exposure drafts IASCF. and interpretations published (IASB) The 12 members are International They make interpretations and consider publicunpaid but have expenses comments and get final approval from IASB. Financial Reporting reimbursed. They meet Before applying for final approval from theevery second month. The Interpretations 12 IASB, the IFRIC need 9 votes out of 12 IFRIC reports to the Committee IASB. (IFRIC) 6 Chapter 1
  • 7. Gripping IFRS The Pillars of Accounting1.4 The International Improvements ProjectDuring the process of harmonisation, new ideas develop that result in changes having to bemade to some of the existing standards and their interpretations. This is what is referred to asthe Improvements Project.1.5 Due process and transparencyBefore a new standard is issued, an exposure draft is first issued. The exposure draft mayonly be issued after approval by at least nine of the fourteen members of the IASB and isissued together with:• the opinions of those members of the IASB who did not approve of the exposure draft and• the basis for the conclusions that were made by the rest of the IASB members.Any interested party may comment on these drafts. The comments received are thoroughlyinvestigated after which the draft is adopted as a new standard (either verbatim or withchanges having been made for the comments received) or is re-issued as a revised exposuredraft for further comment.2. IFRS versus GAAP2.1 OverviewThe Statements of GAAP is short for: Statements of Generally Accepted Accounting Practice.These include the documented acceptable methods used by businesses to ‘recognise, measureand disclose’ business transactions. The best of these statements from all over the world arebeing merged into the IFRSs, which is short for International Financial Reporting Standards.2.2 Compliance with IFRSLegally, financial statements must generally comply with the national statutory requirementsof the relevant country. The problem is that most statutes (laws) of many countries currentlyrequire compliance with either generally accepted accounting practice or the statements ofgenerally accepted accounting practice. A strict interpretation of the requirement to complywith generally accepted accounting practice (GAAP) suggests that ‘if everyone is doing it, socan we’, or in other words, the official Statements or Standards need not be complied with.In all cases, if a country wishes its business entities to use global accounting standards(IFRS), the terms included in that country’s legislation will have to require compliance withinternational financial reporting standards and the interpretations thereof (IFRS) instead.In addition to the requirements of the legal statute of the country, IAS 1 (Presentation ofFinancial Statements) requires that where companies do comply with international financialreporting standards and the interpretations thereof (in their entirety), disclosure of this factmust be made in their financial statements. By implication, those companies that do notcomply, may not make such a declaration. It is obviously beneficial to be able to make such adeclaration since it lends credibility to the financial statements, makes them understandable toforeigners and thus encourages investment. 7 Chapter 1
  • 8. Gripping IFRS The Pillars of Accounting3. The PillarsThis section (and the entire chapter) relates to what I call the ‘pillars of accounting’, a veryimportant area, without which the ‘top floor’ of your knowledge cannot be built. Thefoundations of this ‘building’ were built in prior years of accounting study. If you feel thatthere may be cracks in your foundation, right now is the time to fix them by revising yourwork from prior years. Please read this chapter very carefully because every other chapter inthis book will assume a thorough understanding thereof.There are two areas of the global standards that make up these pillars:• the Framework and• IAS 1: Presentation of Financial Statements.3.1 The FrameworkThe Framework is technically not a standard but the foundation for all standards andinterpretations. It therefore does not override any of the IFRSs but should be referred to asthe basic logic when interpreting and applying a difficult IFRS (the term IFRS includes thestandards and the interpretations). It sets out the:• objective of financial statements, that is to say, the information that each component of a set of financial statement should offer;• underlying assumptions inherent in a set of financial statements;• qualitative characteristics that the financial statements should have;• elements in the financial statements (assets, liabilities, equity, income and expenses);• recognition criteria that need to be met before the element may be recognised in the financial statements;• measurement bases that may be used when measuring the elements; and• concepts of capital and capital maintenance.IFRSs are designed to be used by profit-orientated entities (commercial, industrial andbusiness entities in either the public or private sector) when preparing general purposefinancial statements (i.e. financial statements that are used by a wide variety of users).3.2 IAS 1: Presentation of financial statementsIAS 1 builds onto the Framework and in some areas tends to overlap a little. IAS 1 has as itsmain objective ‘comparability’ and with this in mind, sets out:• the purpose of financial statements;• the general features of a set of financial statements;• the structure and minimum content of the five main components of financial statements: − the statement of financial position (as at the end of the period); − the statement of comprehensive income (for the period); − the statement of changes in equity (for the period); − the statement of cash flows (for the period); and − the notes to the financial statements;• other presentation issues, such as how to differentiate between items that are considered current and those that are considered non-current (necessary when drawing up the statement of financial position). 8 Chapter 1
  • 9. Gripping IFRS The Pillars of Accounting4. The Framework4.1 The objectives of financial statementsThe objective of financial statements is to provide information that is useful to a wide rangeof users regarding the entity’s: • financial position: found mainly in the statement of financial position; • financial performance: found mainly in the statement of comprehensive income; • changes in financial position: found mainly in the statement of changes in equity; and • management’s stewardship of the resources entrusted to it.It is important to note that users are not limited to shareholders and governments, but include,amongst others, employees, lenders, suppliers, competitors, customers and the generalpublic.4.2 Underlying assumptionsThe Framework lists two underlying assumptions:• going concern; and• accrual basis.These are discussed in more depth under overall considerations (see Part 5: IAS 1Presentation of Financial Statements).4.3 Qualitative characteristicsIn order for financial statements to be useful to its users, it must have certain qualitativecharacteristics or attributes. The four main qualities that a set of financial statements shouldhave are listed as follows: • understandability • relevance • reliability • comparability.Although one must try to achieve these qualitative characteristics, the Framework itselfadmits to the difficulty in trying to achieve a balance of characteristics. For example: toensure that the information contained in a set of financial statements is relevant, one mustensure that it is published quickly. This emphasis on speed may, however, affect thereliability of the reports. This balancing act is the fifth attribute listed to in the Framework,and is referred to as constraints on relevant and reliable information.If the four principal qualitative characteristics and the Standards are complied with, oneshould achieve fair presentation, which is the sixth and final attribute listed in the Framework.4.3.1 UnderstandabilityThe financial statements must be understandable to the user but you may assume, in thisregard, that the user has: • a reasonable knowledge of accounting and • a willingness to carefully study the financial information provided.4.3.2 RelevanceWhen deciding what is relevant, one must consider the:• users needs in decision-making: A user will use financial statements to predict, for example, the future asset structure, profitability and liquidity of the business and to confirm his previous predictions. The predictive and confirmatory role of the financial statements is therefore very important to 9 Chapter 1
  • 10. Gripping IFRS The Pillars of Accounting consider when presenting financial statements. By way of example, unusual items should be displayed separately because these, by nature, are not expected to recur frequently;• materiality of the items: Consider the materiality of the size of the item or the potential error in user-judgement if it were omitted or misstated;• nature: For example, reporting a new segment may be relevant to users even if profits are not material.Materiality is a term that you will encounter very often in your accounting studies and is thusimportant for you to understand. The Framework explains that you should considersomething (an amount or some other information) to be material: • if the economic decisions of the users • could be influenced if it were misstated or omitted.Materiality is considered to be a ‘threshold’ or ‘cut-off point’ to help in determining whatwould be useful to users and is therefore not a primary qualitative characteristic. Forexample, all revenue types above a certain amount may be considered to be material to anentity and thus the entity would disclose each revenue type separately.4.3.3 ReliabilityIn order for financial statements to be reliable, they should not include material error or biasand should:• be a faithful representation;• show the substance rather than the legal form of the transaction;• be neutral;• be prudent (but not to the extent that reserves become hidden); and• be complete (within the confines of materiality and cost).4.3.3.1 Faithful representationMost financial statements have some level of risk that not all transactions and events havebeen properly identified and that the measurement basis used for some of the more complextransactions might not be the most appropriate. Sometimes events or transactions can be sodifficult to measure that the entity chooses not to include them in the financial statements.The most common example of this is the internal goodwill that the entity is probably creatingbut which it cannot recognise due to the inability to clearly identify it and the inability tomeasure it reliably.4.3.3.2 Substance over formThis requires that the legal form of a transaction be ignored if the substance or economicreality thereof differs. A typical example here is a lease agreement (the legal document). Theterm ‘lease’ that is used in the legal document suggests that you are borrowing an asset inexchange for payments (rental) over a period of time. Many of these so-called leaseagreements result in the lessee (the person ‘borrowing’ the asset) keeping the asset at the endof the ‘rental’ period. This means that the lease agreement is actually, in substance, not alease but an agreement to purchase (the ‘lessee’ was actually purchasing the asset and notrenting the asset). This lease is referred to as a finance lease, but as accountants, we willrecognise the transaction as a purchase (and not as a pure lease).4.3.3.3 NeutralityFor financial statements to be neutral, they must be free from bias. Bias is the selection orpresentation of information in such a way that you achieve a ‘pre-determined result oroutcome’ in order to influence the decisions of users. 10 Chapter 1
  • 11. Gripping IFRS The Pillars of Accounting4.3.3.4 PrudenceApplying prudence when drawing up financial statements means to be cautious if judgementis required when making estimates under conditions of uncertainty. The idea behindprudence is to: • avoid overstating assets and income, and • avoid understating liabilities and expenses, but without : • creating hidden reserves and excessive provisions, or • deliberately understating assets and income, or • overstating liabilities and expenses for reasons of bias.4.3.3.5 CompletenessFinancial statements need to be as complete as possible given the confines of materiality andcost. This is because omission of information could be misleading and result in informationthat is therefore unreliable and not relevant. Immaterial items may be excluded if too costlyto include.4.3.4 ComparabilityFinancial statements should be comparable:• from one year to the next: therefore, accounting policies must be consistently applied, meaning that transactions of a similar nature should be treated in the same way that they were treated in the prior years; and• from one entity to the next: therefore entities must all comply with the same standards, so that when comparing two entities a measure of comparability is guaranteed.As a result of requiring comparability, users need to be provided with information for thecomparative year and should be provided with the accounting policies used by the entity (andany changes that may have been made to the accounting policies used in a previous year).4.3.5 Constraints to relevance and reliabilityAlthough one must strive to achieve these qualitative characteristics, the Framework itselfadmits to at least two constraints encountered most often when trying to achieve relevanceand reliability in a set of financial statements.These constraints are essentially time and money:• timeliness: − the financial statements need to be issued soon after year-end to be relevant, but this race against time leads to reduced reliability; and• cost versus benefit: − to create financial statements that are perfect in terms of their relevance and reliability can lead to undue effort, with the result that this benefit is outweighed by the enormous cost to the entity; and a• balance among the qualitative characteristics.Bearing in mind that only fresh information is relevant, the 1999 financial statements of abusiness are not relevant to a user in 2008 who is trying to decide whether or not to invest inthat business. The problem is, in the rush to produce relevant and timely financial statements,there is a greater risk that they now contain errors and omissions and are thus unreliable.This balancing act is compounded by the constraint of cost. Money is obviously a constraintin all profit organisations whose basic idea is that the benefit to the business should outweighthe cost. To produce financial statements obviously costs the business money, but this costincreases the faster one tries to produce them (due to costs such as overtime) and the betterone tries to do them (more time and better accountants cost more money). Businesses often 11 Chapter 1
  • 12. Gripping IFRS The Pillars of Accountingfind this a difficult pill to swallow because, on the face of it, it is the business that incurs thesecosts and yet it is the user who benefits. It should be remembered, however, that the benefitsare often hidden. If the user or bank is suitably impressed by your financial statements, thebusiness may benefit by more investment, higher share prices, lower interest rates on bankloans and more business partners, ventures and opportunities.4.4 ElementsThe five elements are as follows:• asset;• liability;• equity;• income; and• expense4.4.1 Asset• a resource• controlled by the entity• as a result of past events• from which future economic benefits are expected to flow to the entity.4.4.2 Liability• a present obligation (not a future commitment!)• of the entity• as a result of past events• the settlement of which is expected to result in an outflow from the entity of economic benefits.4.4.3 Equity• the residual interest in the assets• after deducting all liabilities.4.4.4 Income• an increase in economic benefits• during the accounting period• in the form of inflows or enhancements of assets or decreases in liabilities• resulting in increases in equity (other than contributions from equity participants).4.4.5 Expense• a decrease in economic benefits• during the accounting period• in the form of outflows or depletions of assets or an increase in liabilities• resulting in decreases in equity (other than distributions to equity participants).4.5 RecognitionThe term ‘recognition’ means the actual recording (journalising) of a transaction or event.Once recorded, the element will be included in the journals, trial balance and then in thefinancial statements.An item may only be recognised when it:• meets the relevant definitions (i.e. is an element as defined); and• meets the recognition criteria. 12 Chapter 1
  • 13. Gripping IFRS The Pillars of AccountingThe basic recognition criteria are as follows:• the flow of future economic benefits caused by this element are probable; and• the element has a cost/value that can be reliably measured.Assets or liabilities must meet the recognition criteria in full (must be measured reliably andthe flow of benefits must be probable).Income or expenses need not meet the recognition criteria in full: they only need to bemeasured reliably.It is important to read the definition of income and expense again and grasp how these twoelements may only be recognised when there is a change in the carrying amount of an asset orliability. This means that for an item of income or expense to be recognised, the definition ofasset or liability would first need to be met.4.6 MeasurementIf an item meets the definition of an element and meets the necessary recognition criteria, wewill need to process a journal entry. To do this, we need an amount. The term ‘measurement’refers to the process of deciding or calculating the amount to use in this journal entry.There are a number of different methods that may be used to measure the amounts of theindividual elements recognised in the financial statements, some of which are listed below:• The historical cost method - measures an asset at the actual amount paid for it at the time of the acquisition; and - measures the liability at the amount of cash (or other asset) received as a loan or at the actual amount to be paid to settle the obligation in the normal course of business.• The present value method - measures an asset at the present value of the future cash inflows (i.e. discounted) to be derived from it through the normal course of business; and - measures liabilities at the present value of the future cash outflows (i.e. discounted) expected to be paid to settle the obligation during the normal course of business.• The realisable value method - measures an asset at the cash amount for which it can be currently sold in an orderly disposal; and - measures liabilities at the actual amount of cash (undiscounted) that would be required to settle the liability during the normal course of business.• The current cost method - measures an asset at the amount that would currently have to be paid if a similar asset were to be acquired today; and - measures liabilities at the actual amount of cash (undiscounted) that would be required to settle the liability today.There are a variety of combinations of the above methods, many of which are largely dictatedby the relevant standard. For instance, assets that are purchased with the intention of resaleare measured in terms of IAS 2: Inventories, which states that inventories should be measuredat the lower of cost or net realisable value. Assets that are purchased to be used over morethan one period are measured in terms of IAS 16: Property, Plant and Equipment, whichallows an asset to be recognised at either historical cost or fair value (determined inaccordance with a discounted future cash flow technique: present value, or in terms of anactive market: current cost). Redeemable debentures (a liability) are measured in terms ofIAS 39: Financial Instruments: Recognition and Measurement.Although most companies seem to still be measuring many of their assets at historical cost,there appears to be a definite interest in fair value accounting, where present values andcurrent costs are considered more appropriate than historical cost. There is an argument thatsays that the historical cost basis should be abandoned and replaced by fair value accountingsince the generally rising costs caused by inflation results in the historical amount paid for an 13 Chapter 1
  • 14. Gripping IFRS The Pillars of Accountingitem having no relevance to its current worth. A problem with fair value accounting,however, is its potentially subjective and volatile measurements which could reduce thereliability of the financial statements. The possibility of reduced reliability could be thereason why most companies still use historical costs for many of their assets, where the latestfair values are disclosed in their notes for those users who are interested.4.7 When the element is not recognisedItems that do not meet the relevant definitions and recognition criteria in full may not berecognised in the financial statements. Information about this item may, however, still beconsidered to be ‘relevant’ to the user, in which case it should be disclosed in the notes.4.8 Recognition versus disclosureAs mentioned earlier, the term ‘recognition’ means the actual recording (journalising) of atransaction or event. Once recorded, the element will be included in the journals, trial balanceand then channelled into one of the financial statements: statement of comprehensive income,statement of changes in equity or statement of financial position (all presented on the accrualbasis), as well as the statement of cash flows (a financial statement presented on the cashbasis).The term ‘disclosure’ means giving detail about specific transactions or events that are either:• already recognised in the financial statements; or• not recognised in the financial statements but yet are considered material enough to affect possible economic decisions made by the users of the financial statements.Some items that are recognised may require further disclosure. Where this disclosureinvolves a lot of detail, this is normally given in the notes to the financial statements.Other items that are recognised may not need to be disclosed. For example, the purchase of acomputer would be recorded in the source documents, journals, trial balance and finally in thestatement of financial position. Unless this computer was particularly unusual, it would beincluded in the total of the non-current assets on the face of the statement of financialposition, but would not be separately disclosed anywhere in the financial statements since itwould not be relevant to the user when making his economic decisions.Conversely, some items that are not recognised may need to be disclosed. This happenswhere either the definition or recognition criteria (or both) are not met, but yet theinformation is still expected to be relevant to users in making their economic decisions. Atypical example is a law suit against the entity which has not been recognised because thefinancial impact on the entity has not been able to be reliably estimated but which isconsidered to be information critical to a user in making his economic decisions.4.9 Answering discussion type questionsWhen answering a discussion type question involving the recognition of the elements, it isgenerally advisable to structure your answer as follows:• quote the definition of the relevant element/s and discuss each aspect of it with reference to the transaction in order to ascertain whether or not the definition/s is met;• quote the relevant recognition criteria and then discuss whether the element meets each of the recognition criteria; and• conclude by stating which element the item should be classified as (based on the definition) and then whether or not this element should be recognised at all (based on the recognition criteria).The structure of your answer depends entirely on the wording of the question. If the questionasks for you to discuss the recognition of an element, it may require the word for wordrepetition of both the definitions and recognition criteria unless your question specifically 14 Chapter 1
  • 15. Gripping IFRS The Pillars of Accountingtells you not to give these, in which case, just the discussion is required. Generally eachaspect of the definition and recognition criteria should be discussed fully (use your markallocation as a guide) but some questions may not require a full discussion but may requireyou to identify what element should be recognised and to support this with only a briefexplanation.The question may ask you to prove that the debit or credit entry is a certain element (e.g. aliability), in which case it is generally fine to simply discuss the definition and recognitioncriteria relevant to that element (i.e. the liability). In other cases, you may be required todiscuss which element the debit or credit entry represents, in which case you are generallyrequired to discuss both the asset and expense definitions if it is a debit entry, or the liability,income and perhaps even the equity definitions if it is a credit entry.Your question may ask for a discussion of the issues surrounding measurement, in which casecalculations of the amounts may also be required. If you are only asked to discuss themeasurement of an amount, then do not discuss the recognition issues (i.e. do not discuss thedefinitions and recognition criteria – you will be wasting valuable time).4.10 Some examplesExample 1: benefits earned over more than one period – expense or asset?A machine is purchased for C4 000 in cash. The machine was delivered on the same day asthe payment was made. It is expected to be used over a 4-year period to make widgets thatwill be sold profitably. At the end of the 4-year period, the asset will be scrapped.Required:Discuss how the purchase of the machine should be recognised and measured. Thedefinitions and recognition criteria are not required.Solution to example 1: benefits earned over more than one period – expense or asset?Definition:• A machine is a resource since it can be used to make widgets.• The machine has been delivered (and been paid for) and is thus controlled by the entity.• An inflow of future economic benefits is expected through the sale of the widgets.• The past event is the payment of the purchase price/ delivery of the machine.Since all aspects of the definition of an asset are met, the item (the machine) is an asset to the entity.Recognition criteria:• The cost is reliably measured: C4 000 already paid in full and final settlement.• The inflow of future economic benefits is probable since there is no evidence that the widgets will not be produced and sold.Conclusion:Since both recognition criteria are met, the asset should be recognised. Debit CreditMachine: cost (A) 4 000 Bank (A) 4 000Purchase of machinePS. If you were also asked to briefly prove that the initial acquisition did not involve an expense, thenyou should provide the following discussion as well:Since the entity’s assets simultaneously increased (through the addition of a machine) and decreased(through the outflow of cash), there has been no effect on equity and therefore no expense.Measurement:The measurement on initial recognition is the invoice price (i.e. historical cost basis), but the futureasset balances in the statement of financial position must reflect the state of the asset. As the machine’slife is used up in the manufacturing process, so the remaining future economic benefits (expected 15 Chapter 1
  • 16. Gripping IFRS The Pillars of Accountingthrough its future use) will decrease. Since this decrease in the asset’s value occurs with nosimultaneous increase in assets or decrease in liabilities, the equity of the business will be decreased.The amount by which the asset’s value is reduced is therefore recognised as an expense. Debit CreditJournal in year 1, 2, 3 and 4Depreciation: machine (E) xxx Machine: accumulated depreciation (negative A) xxxDepreciation of machineThe portion of the asset’s value that is recognised as an expense each year is measured on a systematicrational basis over the 4-year period:• If the widgets are expected to be manufactured and sold evenly over the 4-year period, then C1 000 should be expensed in each of these 4 years (C4 000 / 4 years).• If 50% of the widgets are expected to be manufactured and sold in the first year, 30% in the second year and 10% in each of the remaining years, then a more rational and systematic basis of apportioning the expense over the 4 years would be as follows: - Year 1: C4 000 x 50% = 2 000 - Year 2: C4 000 x 30% = 1 200 - Year 3: C4 000 x 10% = 400 - Year 4: C4 000 x 10% = 400Example 2: an inflow – income or liability?A gym receives a lumpsum payment of C4 000 from a new member for the purchase of a 4-year membership.Required:Briefly discuss whether the lumpsum received should be recognised as income or a liability.The definitions of both income and liability should be discussed (ignore recognition criteria).Solution to example 2: an inflow – income or liability?Liability definition:• The entity has an obligation to provide the member with gym facilities over the next 4 years• The past event is the entity’s receipt of the C4 000.• The obligation will result in an outflow of cash, for items such as salaries for the gym instructors, electricity and rental of the gym facilities.Since all aspects of the liability definition are met, the receipt represents a liability.Income definition:• The initial lumpsum represents an increase in cash (an increase in assets)• There is, however, an increase in liabilities since the club is now expected to provide the member with gym facilities for the next 4 years which effectively means that the gym has an equal and opposite obligation (an increase in its liabilities).• For there to be income, there must be an increase in equity: since the increase in the asset equals the increase in the liability, there is no increase in equity (equity = assets – liabilities).Since there is no increase in equity the receipt does not represent income – yet.Conclusion:At the time of the receipt, the lumpsum is recognised as a liability and journalised as follows: Debit CreditBank (A) 4 000 Income received in advance (L) 4 000Gym fees received as a lumpsum in advancePS. Had you not been asked to only discuss the initial lumpsum received, you could then have given thefollowing discussion as well:As time progresses, the gym will discharge its obligation thus reducing the liability. The amount bywhich the liability reduces is then released to income since it meets the definition of income: 16 Chapter 1
  • 17. Gripping IFRS The Pillars of AccountingFor example, after each year of providing gym facilities there is an inflow of economic benefitsthrough the decrease in the liability: the obligation to provide 4 years of gym facilities, drops to 3years, then 2 years, 1 more year and finally the obligation is reduced to zero.In this way, the receipt is recognised as income on a systematic basis over the 4 years during which thethe entity will incur the cost of providing these services (i.e. the income is effectively matched with theexpenses incurred over 4-years). In each of the 4 years during which the gym provides facilities to themember, the following journal will be processed (after processing 4 of these journals, there will be nobalance on the liability account and the entire C4 000 received will have been recognised as income). Debit CreditIncome received in advance (L) 1 000 Membership fees (I) 1 000Portion of the lumpsum recognised as incomeExample 3: staff costs – an asset?Companies often maintain that their staff members constitute their biggest asset. However,the line-item ‘people’ is never seen under ‘assets’ in the statement of financial position.Required:Explain why staff members are not recognised as assets in the statement of financial position.Solution to example 3: staff costs – an asset?In order for ‘staff’ to appear in the statement of financial position as an asset, both the following needto be satisfied:• the definition of an asset; and• the recognition criteria.First consider whether a ‘staff member’ meets the definition of an ‘asset’.• Is the staff member a resource? A staff member is a resource – a company would not pay a staff member a salary unless he/ she were regarded as a resource. In fact, employees are generally referred to as ‘human resources’.• Is he controlled by the entity? Whether or not the staff member is controlled by the entity is highly questionable: it is considered that, despite the existence of an employment contract, there would always be insufficient control due to the very nature of humans.• Is the staff member a result of a past event? The signing of the employment contract could be argued to be the past event.• Are future economic benefits expected to flow to the entity as a result of the staff member? It can be assumed that the entity would only employ persons who are expected to produce future economic benefits for the company.In respect of the asset, the recognition criteria require that• the flow of future economic benefits to the entity must be probable; AND• the asset has a cost/value that can be reliably measured.It is probable that future economic benefits will flow to the entity otherwise the entity would notemploy the staff.The problem arises when one tries to reliably measure the cost/value of each staff member. Howwould one value one staff member over another? Perhaps one could calculate the present value of theirfuture salaries, but there are two reasons why this is unacceptable. Consider the following:• Can you reliably measure the cost of a staff member? If one were to use future expected salaries and other related costs, consider the number of variables that would need to be estimated: the period that the staff member will remain in the employ of the entity, the inflation rate over the expected employment period, the fluctuation of the currency, the future performance of the staff 17 Chapter 1
  • 18. Gripping IFRS The Pillars of Accounting member and related promotions and bonuses. You will surely then agree that a reliable measure of their cost is really not possible.• Since it is evident that we cannot reliably measure the cost of a staff member, can one reliably measure their value in another way? The value of a staff member to an entity refers to the value that he or she will bring to the entity in the future. It goes without saying that there would be absolutely no way of assessing this value reliably!Staff members may therefore not be recognised as assets in the statement of financial position for twomain reasons:• there is insufficient control over humans; and• it is not possible to reliably measure their cost or value.5. IAS 1: Presentation of financial statements: an overview5.1 OverviewIAS 1 was revised in September 2007. The main changes are as follows:• the names of the components of a set of financial statements have been changed; - income statement is now: statement of comprehensive income; - balance sheet is now: statement of financial position; - cash flow statement is now: statement of cash flows;• the introduction of a statement of comprehensive income, which incorporates the ‘old income statement’ followed by ‘other comprehensive income’, the latter being previously included in the statement of changes in equity;• a simplified statement of changes in equity showing only transactions involving owners in their capacity as owners, where transactions that comprise ‘non-owner changes in equity’ (which were previously included) are now included in the statement of comprehensive income as ‘other comprehensive income’;• other changes in terminology: - equity holders are now called: owners - balance sheet date is now called: end of the reporting period - overall considerations are now called: general features• the introduction of an eighth general feature: frequency of reporting.The main reasons given by the IASB for revising IAS 1 included:• an intention to aggregate financial information on the basis of shared characteristics, thus: - changes in equity that are due to transactions with owners in their capacity as owners are included in the statement of changes in equity; whereas - changes in equity that are not due to transactions with owners in their capacity as owners are included in the statement of comprehensive income;• convergence with the USA’s FASB Statement No. 130Reporting Comprehensive Income;• making IAS 1 easier to read.5.2 Scope (IAS 1.2 to IAS 1.6)IAS 1 applies to profit-orientated entities in preparing and presenting general purposefinancial statements. It therefore is not designed to meet the needs of non-profit entities.It is also not designed to meet the needs of condensed interim financial statements, althoughfive of the eight general features in IAS 1 should be applied to interim financial statements:• fair presentation and compliance with IFRSs• going concern• accrual basis of accounting• materiality and aggregation• offsetting. 18 Chapter 1
  • 19. Gripping IFRS The Pillars of AccountingIAS 1 is designed for entities whose share capital is equity. If an entity does not have suchequity, the presentation of owners’ interests would need to be adapted.5.3 Objective of IAS 1 (IAS 1.1)The objective of IAS 1 is to prescribe how to (i.e. the basis on which to) present financialstatements in order to achieve comparability (a qualitative characteristic listed in theFramework):• With the entity’s own financial statements for different periods; and• With other entity’s financial statements.5.4 Objective of financial statements (IAS 1.9 and the Framework)Here is a perfect example of the overlapping between the Framework and IAS1: both includethe objective of financial statements. Financial statements are designed to be a• structured representation of an entity’s financial position, financial performance and cash flows• that is useful to a wide range of users in making economic decisions; and• showing the results of management’s stewardship of the resources entrusted to it.5.5 Definitions (IAS 1.7)The following definitions are provided in IAS 1 (some of these definitions are simplified):General purpose financial statements (referred to as ‘financial statements’):are those intended to meet the needs of users who are not in a position to require an entity toprepare reports tailored to their particular information needs.Impracticable:Applying a requirement is impracticable when the entity cannot apply it after making everyreasonable effort to do so.International Financial Reporting Standards (referred to as IFRSs):are Standards and Interpretations adopted by the IASB (they include the following prefixes:IFRSs, IASs and IFRIC interpretations and SIC interpretations).Materiality of omissions and misstatements of items:Omissions and misstatements are material if they could individually or collectively influencethe economic decisions that users make on the basis of the financial statements. Materialitydepends on the size and nature of the omission or misstatement judged in the surroundingcircumstances. The size or nature of the item, or a combination of both, could be thedetermining factor.Notes:• provide narrative descriptions or disaggregations of items presented in the other financial statements (e.g. statement of financial position); and• provide information about items that did not qualify for recognition in those other financial statements.Profit or loss:• is the total of income less expenses,• excluding the components of other comprehensive income.Other comprehensive income:• Comprises items of income and expense (including reclassification adjustments)• That are either not required or not permitted to be recognised in profit or loss.• The components of other comprehensive income include: 19 Chapter 1
  • 20. Gripping IFRS The Pillars of Accounting (a) Changes in revaluation surplus (IAS 16 Property, plant and equipment and IAS 38 Intangible assets); (b) Actuarial gains and losses on defined benefit plans (being those recognised in accordance with paragraph 93A of IAS 19 Employee Benefits); (c) Gains and losses arising from translating the financial statements of a foreign operation (IAS 21 The effects of changes in foreign exchange rates); (d) Gains and losses on remeasuring available-for-sale financial assets (IAS 39 Financial instruments: recognition and measurement); (e) The effective portion of gains and losses on hedging instruments in a cash flow hedge (IAS 39 Financial instruments: recognition and measurement).Total comprehensive income:• Is the change in equity• during a period• resulting from transactions and other events,• other than those changes resulting from transactions with owners in their capacity as owners.• Total comprehensive income = ‘profit or loss’ + ‘other comprehensive income’.5.6 Complete set of financial statements (IAS 1.10)There are five main statements in a complete set of financial statements:• the statement of financial position (as at the end of the period);• the statement of comprehensive income (for the period);• the statement of changes in equity (for the period);• the statement of cash flows (for the period); and• the notes to the financial statements;The statement of comprehensive income may be provided either as:• a single statement: statement of comprehensive income; or• two separate statements: an income statement (also referred to as a statement of profit or loss), followed by a statement of comprehensive income.The general features, structure and content of these statements are now discussed in detail.6. IAS 1: Presentation of financial statements: general features6.1 OverviewIAS 1 lists eight general features to consider when producing financial statements (notice thatthis list includes two of the underlying assumptions included in the Framework):• fair presentation and compliance with IFRS;• going concern (also an underlying assumption per the Framework);• accrual basis (also an underlying assumption per the Framework);• materiality and aggregation;• offsetting;• frequency of reporting;• comparative information; and• consistency of presentation.6.2 Fair presentation and compliance with IFRSs (IAS 1.15-24)6.2.1 Achieving fair presentation (IAS 1.15 and IAS 1.17)Fair presentation simply means that position, performance and cash flows must be recordedfaithfully (truthfully). 20 Chapter 1
  • 21. Gripping IFRS The Pillars of AccountingFair presentation will generally always be achieved if the transactions, events and conditionsare recorded by:• complying with the definitions and recognition criteria provided in the Framework,• complying with all aspects of the IFRSs; and• providing extra disclosure where necessary.In order to ensure that fair presentation is achieved, the standard emphasises that one must:• select and apply accounting policies in accordance with IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors;• present all information in a manner that provides relevant, reliable, comparable and understandable information (P.S. these are the qualitative characteristics per the Framework); and• provide additional disclosure when the relevant standards are unable to provide the user with sufficient understanding of the impact of certain transactions, events and conditions on the financial position and performance of the entity.6.2.2 Compliance with IFRSs (IAS 1.16 and IAS 1.24)Where all aspects of the IFRS have been complied with, disclosure of this fact must be madein the financial statements. This disclosure may only be made if absolutely all the IFRSs(standards and interpretations) have been complied with in full.6.2.3 Departure from IFRSs (IAS 1.16 and IAS 1.24)In extremely rare circumstances, management may believe that by applying an IFRS thefinancial statements become misleading, so much so that the objective of financial statementsis undermined. In order to come to such a dramatic conclusion, management must consider:• why the objective of financial statements is not achieved in the entity’s particular circumstances; and• how the entity’s circumstances differ from those of other entities that have successfully complied with the IFRS’s requirement/s.The obvious answer to this problem is to depart from the IFRS, but this is not always allowed.6.2.3.1 When departure from an IFRS is required and allowed (IAS 1.19-22)An entity shall depart from an IFRS:• if compliance with the IFRS would result in financial statements that are so misleading that they ‘would conflict with the objective of financial statements set out in the Framework’, and• if the relevant regulatory framework requires or does not prohibit such departure in this situation,The extra disclosure required when there has been departure from an IFRS is as follows:• management’s conclusion that the financial statements ‘fairly present the entity’s financial position, financial performance and cash flows’;• a declaration to the effect that the entity has complied with applicable standards and interpretations of IFRS except that it has departed from a particular standard or interpretation in order to achieve fair presentation;• the name of the standard (or interpretation) from which there has been departure;• the nature of the departure, including the treatment that is required by the standard;• the reason why it was considered to be so misleading;• the treatment adopted; and• the financial impact of the departure on each item that would otherwise have had to be reported had the IFRS been properly complied with. 21 Chapter 1
  • 22. Gripping IFRS The Pillars of AccountingThe same disclosure (with the exception of management’s conclusion and the declarationreferred to above) would be required every year after the departure where that departurecontinues to affect the measurement of amounts recognised in the financial statements.6.2.3.2 When departure from an IFRS is required but not allowed (IAS 1.23)When departure from IFRS is considered necessary for fair presentation but yet is disallowedby the relevant regulatory framework, the financial statements will be misleading. Since theobjective of financial statements is basically to provide useful information, the lack of fairpresentation must be remedied through disclosure of the following:• the name of the IFRS that is believed to have resulted in misleading information;• the nature of the specific requirement in the IFRS that has led to misleading information;• management’s reasons for believing that the IFRS has resulted in financial statements that are so misleading that they do not meet the objectives of financial statements; and• the adjustments that management believes should be made in order to achieve faithful representation.6.3 Going concern (IAS 1.25-26)6.3.1 Financial statement preparation (IAS 1.25)Financial statements should be prepared on the going concern basis unless management:• voluntarily or• involuntarily (i.e. where there is no realistic alternative) plans to: - liquidate the entity; or - simply cease trading.6.3.2 Management’s responsibility (IAS 1.25-26)Management is required to make an assessment of the entity’s ability to continue as a goingconcern.This assessment should:• be made while the financial statements are being prepared;• be based on all available information regarding the future (e.g. budgeted profits, debt repayment schedules and access to alternative sources of financing); and• include a review of the available information relating to, at the very least, one year from statement of financial position date.Such a detailed analysis is not required, however, if the entity has a history of profitableoperations and ready access to funds.6.3.3 If there is significant doubt that the going concern basis is appropriate (IAS 1.25)If cessation or liquidation is not imminent, but there is significant doubt as to the ability of theentity to continue operating, the material uncertainties causing this doubt must be disclosed.6.3.4 If the going concern basis is not appropriate (IAS 1.25)If the entity is not considered to be a going concern, the financial statements must not beprepared on the going concern basis, and disclosure must include:• this fact;• the basis used to prepare the financial statements (e.g. the use of liquidation values); and• the reason why the entity is not considered to be a going concern.6.4 Accrual basis of accounting (IAS 1.27-28)The accrual basis of accounting means recording elements (assets, liabilities, income,expenses and equity) when the definitions and recognition criteria are met. It results in 22 Chapter 1
  • 23. Gripping IFRS The Pillars of Accountingrecognising transactions and events in the periods in which they occur rather than when cashis received or paid.The accrual basis is applied to all components of a set of financial statements, with theexception of statement of cash flows, which obviously uses the cash basis instead.6.5 Materiality and aggregation (IAS 1.29-31)6.5.1 Accountancy involves a process of logical summarisationSimply speaking, the financial process starts with:• a transaction that is first documented (onto a source document);• the document is then journalised (in subsidiary journals);• the journal is then posted (into the subsidiary and general ledger);• the ledger is summarised into the trial balance;• the trial balance is summarised into the detailed set of financial statements – a summary used by internal users (e.g. management); and• these financial statements are then further summarised into what is referred to as the published set of annual financial statements.The published annual financial statements do not show extensive detail because they aremade available to a wide range of external users who would find that too much informationwould be confusing and irrelevant to their decision-making. It is interesting to note that it isonly these published financial statements that are subjected to the disclosure requirementslaid out in the IFRS. Transaction/ event Source document Journal Ledger Trial balance Unabridged financial statements Detailed statement of financial position Detailed statement of comprehensive income Published financial statements Summary statement of financial position Summary statement of comprehensive income 23 Chapter 1
  • 24. Gripping IFRS The Pillars of Accounting6.5.2 Deciding whether an item is material and needs to be segregated (IAS 1.29-31)Each class of items that is material should be separately disclosed (segregated). Where aclass of items is immaterial, it must be aggregated (included) with another class of items.IAS 1 refers to a class of items as having a bearing on the nature or function of the items.Materiality is a term that you will encounter very often in your accounting studies and is thusimportant for you to understand. Both the Framework and IAS 1 explain that you shouldconsider something to be material if the economic decisions of the users could be influencedif it were misstated or omitted. It is a threshold or cut-off point used to help identify whethersomething may be useful to a user. For example, an entity may have a materiality thresholdfor revenue of C100 000, with the result that any revenue types that exceed C100 000 will beseparately disclosed.A class of items that is very material may require disclosure separately on the face of thefinancial statements whereas another class of items, although material, may only requireseparate disclosure in the notes. It is a subjective decision requiring professional judgement.So in summary, when considering whether to segregate (present separately) or aggregate anitem (present as part of another total), consider its class, (being its nature or function) and ifyou think that knowledge of it:• would affect the economic decisions of the user, then the item is material and should be disclosed separately (i.e. should be segregated); or• would not affect the economic decisions of the user, then the item is not material and should not be disclosed separately (i.e. should be aggregated).It is generally not considered necessary for an item to be material in nature, function and sizebefore it should be separately disclosed, but logic should prevail.Example 4: items with different functionsExplain whether or not the following classes should be separately disclosed: :• inventory; and• property, plant and equipment.Solution to example 4: items with different functionsThe function of inventory is to be sold at a profit whereas the function of property, plant and equipmentis to be kept and used by the entity. The functions of these two assets are considered to be so differentthat they are considered sufficiently material to be disclosed separately on the face of the statement offinancial position.Example 5: items with different natures, but immaterial sizeThe total carrying amount of furniture is C100 000, and the total carrying amount of land isC50 000. The company’s materiality limit is C300 000.Required:Explain whether or not the furniture and land should be disclosed as two separate categories.Solution to example 5: items with different natures, but immaterial sizeAlthough the carrying amount of each class is below the materiality limit, the two classes would bedisclosed separately (generally only in the notes) since although the assets may be argued to be similarin the sense that both are assets to be used in the business, the difference in function or nature of each ismaterial enough for the amount spent on each to be relevant to the economic decisions of the user. 24 Chapter 1
  • 25. Gripping IFRS The Pillars of AccountingExample 6: items that are material in size, but not in nature or functionA company’s materiality limit is C300 000 and the total carrying amount of its:• machinery is C500 000, including machine A, with a carrying amount of C450 000;• office furniture is C300 000; and• office equipment is C310 000.Required:Explain whether or not:• machine A should be separately disclosed from other machinery based on size; and• furniture and office equipment should be disclosed as two separate categories based on the size of the carrying amounts of each category relative to the materiality limit.Solution to example 6: items that are material in size, but not in nature or functionMachine A and the other machinery:Despite the fact that machine A is material in size, machine A should not be separately disclosed since,with reference to most user’s needs, this is not material in function or nature (a separate description ofmachine A would be information more of a technical than a financial nature and would thus mean verylittle to most general users).Furniture and office equipment:Similarly, despite the materiality of the individual sizes of the carrying amounts involved, officefurniture and office equipment could be aggregated due to their common function or nature: office use.Although office furniture and machinery represent two dissimilar classes on the basis that theirfunctions are so diverse, furniture and machinery should be aggregated on the face of the statement offinancial position because, at this overall level of presentation, the class of asset becomes immaterial.What is more important on the face of the statement of financial position is that different categories ofassets, such as property, plant and equipment versus inventory are separated. The detail of the materialclasses within the categories of property, plant and equipment and inventory are included in the notes.It should be noted, that where functions are materially different but amounts are immaterial, it may stillbe necessary to disclose separately in the notes, being a matter of judgement, once again.6.5.3 What to do with immaterial items (IAS 1.30-31)Immaterial items are aggregated with other items. For instance, each and every item offurniture would not be listed separately in the statement of financial position, but would beaggregated with all other items of furniture since they are similar in nature and it is notmaterial to the user to know the value of each individual chair, table and lamp at year-end.Instead, it would be more useful to the user to simply know the total spent on furniture.6.6 Offsetting (IAS 1.32-35)There should be no offsetting of:• income and expenses; or• assets and liabilitiesunless it:• reflects the substance of the transaction; and• is either allowed or required in terms of the related standard or interpretation.An example of the allowed off-setting of income and expenses would be in the calculation ofthe profit or loss on sale of a non-current asset. The proceeds of the sale (income) may be setoff against the carrying amount of the asset (now expensed) together with any sellingexpenses, with the result that the substance of the transaction is reflected.An example of the setting off of income and expenses that is not allowed is revenue from asale and the related cost of the sale since revenue is required, in terms of the relevant standard(IAS 18: Revenue), to be disclosed separately. 25 Chapter 1
  • 26. Gripping IFRS The Pillars of AccountingAn example of when offsetting is required is IAS 16: Property, Plant and Equipment, wherethe cost of acquiring an asset must be reduced by the proceeds earned through the incidentalsale of any item that may have been produced while bringing the asset to a useful location andcondition (e.g. the sale of samples made when testing the asset before bringing it into use).Example 7: sale of a machine (set-off is allowed)During 20X2, a machine (a non-current asset) with a carrying amount of C20 000 is sold forC30 000.Required:Disclose the above transaction in the statement of comprehensive income.Solution to example 7: sale of a machine (set-off is allowed)Company nameStatement of comprehensive incomeFor the year ended ….. (extracts) Calculations 20X2 COther income- Profit on sale of machine 30 000 – 20 000 10 000Explanation: Since the sale of the machine is considered to be incidental to the main revenuegeneration of the business, the income may be disclosed net of the expense.Example 8: sale of a machine (set-off is not allowed)A company, whose business is to buy and sell machines, sold a machine for C30 000 (originalcost of the machine was C20 000) during 20X2.Required:Disclose the above transaction in the statement of comprehensive income.Solution to example 8: sale of a machine (set-off is not allowed)Company nameStatement of comprehensive incomeFor the year ended ….. (extracts) 20X2 CRevenue 30 000Cost of sales 20 000Explanation: since the sale of the machine is considered to be part of the main revenue generation ofthe business, the disclosure of the income is governed by IAS 18: Revenue and must therefore be showngross (i.e. not shown net of the expense).Example 9: cost of a machine (set-off is required)An entity bought a machine on 31 December 20X2 that it intended to keep for 10 years. Itcost C30 000. Before the machine could be brought into use, it had to be tested: this costC5 000. During the testing process, 1 000 widgets were produced, which were all soldimmediately at C1 each. IAS 16 (paragraph 17) requires that the cost of the asset becalculated after deducting net proceeds from selling any items produced when testing.Required:Disclose the machine in the statement of financial position as at 31 December 20X2. This isthe only item of property, plant and equipment owned by the entity. 26 Chapter 1
  • 27. Gripping IFRS The Pillars of AccountingSolution to example 9: cost of a machine (set-off is required)Company nameStatement of financial positionAs at 31 December 20X2 (extracts) Calculations 20X2 CProperty, plant and equipment 30 000 + 5 000 – 1 000 x C1 34 0006.7 Frequency of reporting (IAS 1.36-37)Entities are required to produce financial statements at least annually. Some entities prefer,for practical reasons, to report on a 52-week period rather than a 365-day period. This is fine!Sometimes, however, an entity may change its year-end, with the result that the reportingperiod is either longer or shorter than a year. The entity must then disclose:• The reason for the longer or shorter period; and• The fact that the current year figures are not entirely comparable with prior periods.It is interesting to note that amounts in the current year’s statement of position would still beentirely comparable with the prior year’s statement because a statement of position is merelya listing of values on a specific day rather than over a period of time. On the other hand, theamounts in the current year’s statement of comprehensive income would not be comparablewith the prior year’s statement since the amounts in each year reflect different periods.6.8 Comparative information (IAS 1.38-44)6.8.1 When there has been no change in presentation (IAS 1.38-39; 41-42)For all statements making up the complete set of financial statements, a minimum of one yearof comparative figures is required (i.e. this means that there would be two statements offinancial position: one for the current year and one for the prior year). This requirement forcomparative information applies equally to both numerical and narrative information.With regard to narrative information, however, prior year narrative information need not begiven if it will not enhance the understanding of the current period’s financial statements. Anexample: information as to how a court case was resolved in the prior year would no longerbe relevant to the current year financial statements.Conversely, narrative information that was provided in the prior year may need to be followedup with narrative information in the current year, if it will enhance the usefulness of thefinancial statements. An example: when the prior year financial statements includedinformation regarding an unresolved court case, details regarding how this court case wasresolved during the current year or the status of the dispute at the end of the current year (ifthe case is still not yet resolved) would enhance the usefulness of the financial statements andshould therefore be disclosed.6.8.2 When there has been a change in presentation (IAS 1.41-44 and IAS 1.39)A change in presentation occurs if there is a retrospective change in accounting policy,restatement of prior year figures when correcting an error or a reclassification of items. Inorder to ensure comparability from one year to the next, when the current year presentationdiffers from that in the prior year, the comparative information must be reclassified. 27 Chapter 1
  • 28. Gripping IFRS The Pillars of AccountingIf there has been such a change in presentation in the current year, • the prior period information should be adjusted accordingly; • the following additional disclosures are required: − the nature of the reclassification − the amount of the items affected; − the reason for reclassification; and • an additional statement of financial position is required showing the balances at the beginning of the earliest comparative period (i.e. it now needs two sets of comparatives).If the recalculation of the prior period’s figures based on the new approach is impracticable, • the following must be disclosed instead: − the reason for not reclassifying; and − the nature of the changes that would have been made had the figures been reclassified.Example 10: reclassification of assetsAn entity’s nature of business changed in 20X3 such that vehicles that were previously heldfor use became stock-in-trade (i.e. inventory). The unadjusted property, plant and equipmentbalances are as follows:• 20X2: C100 000 (C60 000 being machinery and C40 000 being vehicles)• 20X3: C150 000 (C80 000 being machinery and C70 000 being vehicles).Required:Disclose the assets in the statement of financial position and notes as at 31 December 20X3.Solution to example 10: reclassification of assetsEntity nameStatement of financial positionAs at 31 December 20X3 (EXTRACTS) 20X3 20X2 Notes C C RestatedProperty, plant and equipment 8 80 000 60 000Inventory 8 70 000 40 000Entity nameNotes to the financial statementsFor the year ended 31 December 20X3 (EXTRACTS)8. Reclassification of assets Previously inventory was classified as part of property, plant and equipment whereas it is now classified separately. The reason for the change in the classification is that the nature of the business changed such that vehicles previously held for use are now held for trade. IAS 2: Inventories requires inventories to be classified separately on the face of the statement of financial position. The amount of the item that has been reclassified is as follows: 20X3 20X2 C C • Inventory 70 000 40 000 28 Chapter 1
  • 29. Gripping IFRS The Pillars of Accounting6.9 Consistency of presentation (IAS 1.45-46)The presentation and classification of items should be the same from one period to the nextunless:• there is a significant change in the nature of the operations; or• the current financial statement presentation is simply not the most appropriate; or• a change in presentation is required as a result of an IFRS;and• the revised presentation and classification is likely to continue; and• the revised presentation and classification is reliable and more relevant to users.If the presentation in the current year changes, then the comparative information must beadjusted with relevant disclosures (see comparative information above).7 IAS 1: Presentation of financial statements: structure and content7.1 The financial report (IAS 1.49-50)A financial report is published at least annually. Included in this annual report are• the financial statements (including five main statements); and• a variety of other statements and reports, which may or may not be required.The purpose of financial statements is to provide information regarding financial position,financial performance and cash flows that are useful in the economic decision-making of awide range of users. They are also intended to be an account of management’s stewardship ofthe resources entrusted to it (a report on how management looked after the entity’s net assets).Since the IFRSs only apply to the financial statements, it is important that any otherstatements and reports are separately identified and not confused with the financialstatements.7.1.1 The financial statementsThere are five main statements in a set of financial statements, all governed by IFRS:• statement of financial position;• statement of comprehensive income;• statement of changes in equity;• statement of cash flows; and the• notes to the financial statements.7.1.2 Other statements and reportsOther statements and reports are often included in the financial report. These could beincluded voluntarily, as a result of other legislative requirements or included as a response tocommunity concerns (e.g. environmental reports might be included to satisfy current publicconcerns regarding global warming). Other examples include:• an index (no financial statements come without this!);• directors’ report;• audit report• environmental report (not compulsory but yet is encouraged);• value-added statement (not compulsory but yet is encouraged); and a• variety of other reports that may be compulsory or advisable for fair presentation. 29 Chapter 1
  • 30. Gripping IFRS The Pillars of Accounting7.2 Identification issues (IAS 1.51-53)The financial statements, being governed by the IFRS, must be clearly identified from the restof the annual report, since the rest of the report is not governed by the IFRS.For obvious reasons, each statement (e.g. statement of comprehensive income) in the financialstatements needs to be clearly identified.Other items may need to be prominently displayed and repeated where necessary (e.g. on thetop of each page) where it affords a better understanding of the financial information.Examples of these other items include:• the name of the entity (and full disclosure of any change from a previous name);• the fact that the financial statements apply to an individual entity or a group of entities;• relevant dates: date of the end of the reporting period for the statement of financial position or the period covered for other statements (e.g. statement of cash flows);• presentation currency (e.g. pounds, dollars, rands); and the• level of rounding used (i.e. figures in a column that are rounded to the nearest thousand, such as C100 000 shown as C100, should be headed up ‘C’000’).7.3 The statement of financial position7.3.1 OverviewThe statement of financial position gives information regarding the entity’s financial position.There were no prizes for guessing that one!The Framework explains that the position of the entity is represented by:• economic resources controlled by the entity;• financial structure;• liquidity; and• solvency.The statement of financial position summarises the trial balance into the three main elements:• assets;• liabilities; and• equity.These three elements are then categorised under two headings:• assets; and• equity and liabilities.The assets and liabilities are then generally separated into two further categories:• current; and• non-current.7.3.2 Current versus non-current (IAS 1.60-65)Assets and liabilities must be separated into the basic categories of current and non-current,unless simply listing them in order of liquidity gives reliable and more relevant information.No matter whether your statement of financial position separates the assets and liabilities intothe categories of current and non-current or simply lists them in order of liquidity, if the itemincludes both a portion that:• is current (i.e. will be realised (settled) within 12 months after the reporting date); and that• is non-current (i.e. will be realised (or settled) later than 12 months after reporting date),the non-current portion must be separately disclosed somewhere in the financial statements.This may be done in the notes rather than in the statement of financial position. 30 Chapter 1
  • 31. Gripping IFRS The Pillars of AccountingWhere the assets and liabilities are monetary assets or liabilities (i.e. financial assets orliabilities) disclosure must be made of their maturity dates. An example of a monetary assetis an investment in a fixed deposit. An example of a monetary liability is a lease liability.Where the assets and liabilities are non-monetary assets or liabilities, disclosure of thematurity dates is not required but is encouraged since these dates would still be useful inassessing liquidity and solvency. For instance, inventory (a non-monetary asset) that is notexpected to be sold within a year should be separately identified in the notes with anindication as to when it might be sold. Land is another example of a non-monetary asset. Aprovision is an example of a non-monetary liability.7.3.3 Assets (IAS 1.66-68 and IAS 1.70)7.3.3.1 Current assets versus non-current assetsCurrent assets are assets:• that are expected to be realised within 12 months after the reporting period;• that are expected to be sold, used or realised (converted into cash) as part of the normal operating cycle (where the ‘operating cycle’ is the period between purchasing assets and converting them into cash or a cash equivalent);• that are held mainly for the purpose of being traded; or• that are cash and cash equivalents - so long as they are not restricted in their use within the 12 month period after the reporting period. For example, a cash amount received by way of donation, a condition to which is that it must not be spent until 31 December 20X5 may not be classified as a current asset until 31 December 20X4 (12 months before).Non-current assets are simply defined as those assets that:• are not current assets.It is interesting to note that assets that are part of the normal operating cycle (for example:inventories and trade receivables) would always be considered to be current and do not needto be realised, sold or used within 12 months after the reporting period.Marketable securities (e.g. an investment in shares) are not considered to be part of theoperating cycle (since they are not integral to the fundamental operations of the business) andtherefore need to be realised within 12 months from reporting date to be considered current.7.3.4 Liabilities (IAS 1.69-76)7.3.4.1 Current liabilities versus non-current liabilities (IAS 1.69-71)Current liabilities are liabilities:• that are expected to be settled within 12 months after the reporting period;• the settlement of which are expected within the normal operating cycle (operating cycle: the period between purchasing materials and converting them into cash/ cash equivalent);• that are held mainly for trading purposes; or• the settlement of which the entity does not have an unconditional right to defer for at least 12 months after the reporting period.Non-current liabilities are simply defined as those liabilities that:• are not current liabilities.It is interesting to note that liabilities that are considered to be part of the normal operatingcycle (e.g. trade payables and the accrual of wages) would always be treated as currentliabilities since they are integral to the main business operations – even if payment is expectedto be made more than 12 months after the reporting period.Examples of liabilities that are not part of the normal operating cycle include dividendspayable, income taxes, bank overdrafts and other interest bearing liabilities. For these 31 Chapter 1
  • 32. Gripping IFRS The Pillars of Accountingliabilities to be classified as current liabilities, settlement thereof must be expected within 12months after the reporting period.Example 11: classification of liabilitiesAn entity has two liabilities at 31 December 20X3:• a bank loan of C500 000, payable in annual instalments of C100 000 (the first instalment is payable on or before 31 December 20X4); and• the electricity account of C40 000, payable immediately.Required:Disclose the liabilities in the statement of financial position and notes at 31 December 20X3assuming that the entity discloses its assets and liabilities:A In order of liquidityB Under the headings of current and non-current.Ignore comparatives.Solution to example 11A: liabilities in order of liquidityEntity nameStatement of financial positionAs at 31 December 20X3 (EXTRACTS) Notes 20X3 CBank loan 8 500 000Accounts payable 40 000Entity nameNotes to the financial statementsFor the year ended 31 December 20X3 (extracts) 20X38. Bank loan C Total loan 500 000 Portion repayable within 12 months 100 000 Portion repayable after 12 months 400 000 The bank loan is expected to be settled in 5 annual instalment of C100 000, the first of which is due to be paid on or before 31 December 20X4. Interest is charged at xx%.Solution to example 11B: liabilities using current and non-currentEntity nameStatement of financial positionAs at 31 December 20X3 (extracts) Notes 20X3Non-current liabilities C Bank loan 8 400 000Current liabilities Current portion of bank loan 8 100 000 Accounts payable 40 000 32 Chapter 1
  • 33. Gripping IFRS The Pillars of AccountingEntity nameNotes to the financial statementsFor the year ended 31 December 20X3 (extracts) 20X38. Bank loan C Total loan 500 000 Portion repayable within 12 months 100 000 Portion repayable after 12 months 400 000 The bank loan is expected to be settled in 5 annual instalment of C100 000, the first of which is due to be paid on or before 31 December 20X4. Interest is charged at xx%.7.3.4.2 Refinancing of financial liabilities (IAS 1.71-73 and IAS 1.76)Refinancing a financial liability means to postpone the due date for repayment. When aliability that was once non-current (e.g. a 5-year bank loan) falls due for repayment within 12months after reporting period, it needs to be reclassified as current. If it was possible torefinance this liability resulting in the repayment being delayed beyond 12 months after theend of the reporting period, then the liability could remain classified as non-current.There are, however, only two instances where the possibility of refinancing may be used toavoid having to classify a financial liability as a current liability:• where an agreement is obtained that allows repayment of the loan to be delayed beyond the 12-month period after the reporting period; - where the original term of the loan was for a period of more than 12 months (i.e. the liability started its life as a non-current liability), and - the agreement is signed before the reporting date; (where this agreement is only signed after the reporting date but before approval of the financial statements, this would be a ‘non-adjusting post-reporting period event’ and could not be used as a reason to continue classifying the liability as non-current); and• where the existing loan agreement includes an option to refinance or roll-over the obligation (i.e. to delay repayment of) where: - the option enables a delay until at least 12 months after the reporting period, and - the option is at the discretion of the entity (as opposed to the bank, for example), and - the entity intends to refinance or roll over the obligation.Example 12: liabilities and refinancing of due paymentsA loan of C100 000 is raised in 20X1. This loan is to be repaid in 2 instalments as follows:• C40 000 in 20X5; and• C60 000 in 20X6.An agreement is reached, whereby the payment of the C40 000 need only be made in 20X6.Required:Show the statement of financial position at 31 December 20X4 (year-end) assuming that:A the agreement is signed on 5 January 20X5;B the agreement is signed on 27 December 20X4. 33 Chapter 1
  • 34. Gripping IFRS The Pillars of AccountingSolution to example 12A: loan liability not refinanced in timeEntity nameStatement of financial positionAs at 31 December 20X4 20X4 20X3LIABILITIES AND EQUITY C CNon-current liabilities 60 000 100 000Current liabilities 40 000 -Note: although the liability has to be separated into a current and non-current portion, note disclosureshould be included to explain that the current liability of C40 000, is now a non-current liability due tothe signing of a refinancing agreement during the post-reporting period.Solution to example 12B: loan liability is refinanced in timeEntity nameStatement of financial positionAs at 31 December 20X4 20X4 20X3LIABILITIES AND EQUITY C CNon-current liabilities 100 000 100 000Example 13: refinancing of a loanNeedy Limited has a loan of C600 000, payable in 3 equal annual instalments. The firstinstalment is due to be repaid on 30 June 20X4.Required:Disclose the loan in the statement of financial position of Needy Limited as at31 December 20X3 (year-end) assuming that the existing loan agreement:A provides the entity with the option to refinance the first instalment for a further 7 months and the entity plans to utilise this facility;B provides the entity with the option to refinance the first instalment for a further 4 months and the entity plans to utilise this facilityC provides the entity with the option to refinance the first instalment for a further 7 months but the entity does not plan to postpone the first instalmentD provides the bank with the option to allow the first instalment to be delayed for 7 months.Solution to example 13: refinancing of a loanEntity nameStatement of financial position (A) (B) (C) (D)As at 31 December 20X4 20X3 20X3 20X3 20X3LIABILITIES AND EQUITY C C C CNon-current liabilities 600 000 400 000 400 000 400 000Current liabilities 0 200 000 200 000 200 000Note: under scenario B, the extra 4 months only extends the repayment to 31 October 20X4 and notbeyond 31 December 20X4.7.3.4.3 Breach of covenants and the effect on liabilities (IAS 1.74-76)Covenants (other terms you could use: provisions/ undertakings / promises made by theborrower to the lender) are sometimes included in the loan agreement. If a covenant isbreached (broken), the lender may be entitled to demand repayment of a portion of the loan –or even the entire amount thereof.Therefore, if there has been a breach of such a covenant (e.g. the borrower promises to keepthe current ratio above 2:1 but then allows the current ratio to drop below 2:1), that portion of 34 Chapter 1
  • 35. Gripping IFRS The Pillars of Accountingthe liability that can be recalled (i.e. the portion that the lender may demand repayment of)should automatically be disclosed as current unless:• the lender agrees prior to the end of the reporting period to grant a period of grace to allow the entity to rectify the breach;• the period of grace lasts for at least 12 months after the reporting period; and• the lender may not demand immediate repayment during this period.If such an agreement is signed after the end of the reporting period but before the financialstatements are authorised for issue, this information would be disclosed in the notes but theliability would have to remain classified as current.Example 14: breach of covenantsWhiny Limited has a loan of C500 000, repayable in 20X9. The loan agreement includes thefollowing condition: if widget units sold by 31 December of any one year drops below12 000, then 40% of loan becomes payable immediately. At 31 December 20X3 unit saleswere 9 200.The company reached an agreement with the bank such that they were granted a grace period.Required:Disclose the loan in the statement of financial position as at 31/12/20X3 assuming that theagreement was signed on:A 31 December 20X3, giving the entity a 14-month period of grace during which the bank agreed not to demand repayment;B 31 December 20X3, giving the entity a 14-month period of grace (although the bank reserved the right to revoke this grace period at any time during this period and demand repayment);C 31 December 20X3, giving the entity a period of grace to 31 January 20X4 during which the bank agreed not to demand repayment. At 31 January 20X4, the breach had been rectified;D 2 January 20X4, giving the entity a 14-month period of grace during which the bank agreed not to demand repayment.Solution to example 14: breach of covenantsEntity nameStatement of financial position (A) (B) (C) (D)As at 31 December 20X3 20X3 20X3 20X3 20X3LIABILITIES AND EQUITY C C C CNon-current liabilities 500 000 300 000 300 000 300 000Current liabilities 0 200 000 200 000 200 000Note: in scenario C, a note should be included to say that a period of grace was given and that thebreach was rectified after the end of the reporting period.In scenario D, a note should be included to say that a period of grace had been granted after the end ofthe reporting period that provided a grace period of more than 12 months from reporting date.7.3.5 Disclosure: in the statement of financial position (IAS 1.54-55)According to IAS 1, the following items must be disclosed in the statement of financialposition in order to meet the minimum disclosure requirements:• property, plant and equipment;• investment property;• intangible assets;• financial assets; 35 Chapter 1
  • 36. Gripping IFRS The Pillars of Accounting• investments accounted for using the equity method (this is a financial asset but one that requires separate disclosure);• biological assets (e.g. sheep);• inventories;• trade and other receivables (a financial asset but one that requires separate disclosure);• cash and cash equivalents (a financial asset but one that requires disclosure separate to the other financial assets);• financial liabilities;• trade and other payables (a financial liability but one that requires separate disclosure);• provisions (a financial liability but one that requires separate disclosure);• tax liabilities (or assets) for current tax;• deferred tax liabilities (or assets);• assets (including assets held within disposal groups held for sale) that are held for sale in terms of IFRS 5 Non-current Assets Held for Sale;• liabilities that are included in disposal groups classified as held for sale in terms of IFRS 5 Non-current Assets Held for Sale;• minority interests (presented within equity);• issued capital and reserves attributable to equity holders of the parent; and• any additional line-items, headings and sub-totals considered to be relevant to the understanding of the entity’s position.Whether or not to disclose additional line items on the face of the statement of financialposition requires an assessment of the following:• Assets: the liquidity, nature and function of assets; examples include: - cash in bank is separated from a 6-month fixed deposit since the liquidity differs; - property, plant and equipment is shown separately from intangible assets since their nature differs (tangible versus intangible); - inventory is shown separately from intangible assets since their functions differ (buy to sell versus buy to use).• Liabilities: the amounts, timing and nature of liabilities; examples include: - C100 000 of a C500 000 long-term loan is repayable within 12 months of reporting date, thus requiring C100 000 to be disclosed separately as a current liability and C400 000 as non-current (based on the timing of the liability); - provisions are shown separately from tax payable since their natures differ.7.3.6 Disclosure: either in the statement of financial position or notes (IAS 1.77-80)7.3.6.1 Sub-classifications (IAS 1.77-78)The line items in the statement of financial position may be broken down further into sub-classifications.These sub-classifications may be shown either as:• a line item in the statement of financial position; or• in the notes.The sub-classifications to be provided depend on:• the disclosure requirements of the IFRSs: - Example: IAS 16 Property, Plant and Equipment requires that the total be broken down into the different classes of land, buildings, plant, machinery, vehicles etc;• the materiality of the amounts, liquidity, nature and function of assets: - Example: inventory that is slow-moving should be separately shown from inventory that is expected to sell within a normal period of time since their liquidity is different; - Example: trade and other accounts receivable should be broken-down into trade accounts receivable, expenses prepaid and other amounts receivable since their natures are different; - Example: office equipment should be separately shown from factory equipment because their functions differ (administrative versus manufacturing); - 36 Chapter 1
  • 37. Gripping IFRS The Pillars of Accounting• the materiality of the amounts, timing and nature of liabilities: - Example: trade and other accounts payable should be broken-down into trade accounts payable and other amounts payable since their natures are different; - Example: a bank overdraft that is payable on demand should be shown separately from a short-term loan that is payable within 2 months since the timing of the payments differ.7.3.6.2 Extra detail (IAS 1.79-80)IAS 1 requires extra detail to be disclosed regarding two items that are included in thestatement of financial position:• share capital; and• reserves.Disclosure of the required extra detail may be provided:• in the statement of financial position; or• in the statement of changes in equity; or• in the notes.It is generally, however, a good idea to keep the face of the statement as simple anduncluttered as possible, disclosing as much as possible in the notes.For each class of share capital, the extra detail that must be disclosed includes:• the number of shares authorised;• the number of shares issued and fully paid for;• the number of shares issued but not yet fully paid for;• the par value per share or that they have no par value;• a reconciliation of the number of outstanding shares at the beginning and end of the year;• rights, preferences and restrictions attaching to that class;• shares in the entity held by the entity itself, or its subsidiaries or its associates; and• shares reserved for issue under options and sales contracts, including terms and amounts.In a situation where an entity has no share capital, (e.g. a partnership), disclosure that is equalto the above should be made regarding each category of equity interest instead.For each reserve within equity, the extra detail that must be disclosed includes:• its nature; and• its purpose.7.3.7 A typical statement of financial position7.3.7.1 OverviewThe following are examples of what a statement of financial position might look like. Theline items needed for your entity might be fewer or more than those shown in these examples:it depends entirely on what line-items are relevant to your entity (e.g. if an entity does nothave goodwill, then this line-item will not appear on its statement).Remember that if the ‘liquidity format’ provides more meaningful disclosure for your entitythan the ‘current : non-current’ classification, then the statement of financial position willlook just the same but without the headings ‘current’ and ‘non-current’.The total equity on the statement of financial position is equal to the total equity on thestatement of changes in equity. If you are required to present both a statement of financialposition and a statement of changes in equity, then good exam technique would be to startwith the statement of changes in equity and then, when preparing your statement of financialposition, put the total equity per your statement of changes in equity in as ‘issued shares andreserves’. There is nothing stopping you from listing the types of equity on the statement offinancial position, except that it is not necessary and wastes valuable exam time! 37 Chapter 1
  • 38. Gripping IFRS The Pillars of Accounting7.3.7.2 Sample statement of financial position of a simplified, single entityThis is an example of a statement of financial position that might apply to a single entity. Thestatement of financial position of this single entity has been further simplified to show a verybasic situation where, for example, the entity does not have investments of any kind and doesnot have non-current assets held for disposal.ABC LtdStatement of financial positionAs at 31 December 20X2 20X2 20X1 C’000’s C’000’sASSETS X XNon-current assets X XProperty, plant and equipment X XGoodwill X XOther intangible assets X XCurrent assets X XInventories X XTrade and other receivables X XCash and cash equivalents X XEQUITY AND LIABILITIES X XIssued share capital and reserves X XNon-current liabilities X XLong-term borrowings X XDeferred tax X XProvisions X XCurrent liabilities X XTrade and other payables X XCurrent portion of long-term borrowings X XShort-term borrowings X XCurrent tax payable X X7.3.7.3 Sample statement of financial position of a group of entitiesThis is an example of a statement of financial position that might apply to a group of entities.You will notice that where a statement of financial position shows a group of entities, the totalequity has to be broken down into the portion that belongs to the minority interest group andthe portion that belongs to the owners of the parent company. This example includes moreline-items than the previous simplified example: it now includes a variety of investments aswell as non-current assets held for sale. 38 Chapter 1
  • 39. Gripping IFRS The Pillars of AccountingABC LtdConsolidated statement of financial positionAs at 31 December 20X2 20X2 20X1 C’000’s C’000’sASSETS X XNon-current assets X XProperty, plant and equipment X XGoodwill X XOther intangible assets X XInvestment properties X XInvestments in associates X XAvailable-for-sale investments X XNon-current assets held for disposal X XCurrent assets X XInventories X XTrade and other receivables X XCash and cash equivalents X XEQUITY AND LIABILITIES X XTotal equity (issue capital and reserves) X X- belonging to shareholders of the parent company X X- belonging to the minority shareholders X XNon-current liabilities X XLong-term borrowings X XDeferred tax X XProvisions X XCurrent liabilities X XTrade and other payables X XCurrent portion of long-term borrowings X XShort-term borrowings X XCurrent tax payable X XCurrent provisions X X7.4 The statement of comprehensive income (IAS 1.81-105)7.4.1 Overview (IAS 1.81; 1.84; i.88; 1.99 and 1.104)The statement of comprehensive income gives information regarding the financialperformance of the entity.Comprehensive income basically includes two parts:• profit or loss (income and expenses); and• other comprehensive income (income and expenses that are not required or not permitted to be recognised in profit or loss).7.4.2 Profit or loss (IAS 1.88 and 1.91)Profit or loss includes items that are recognised as income and expense. The net of theincome and expenses results in either a profit or loss.This profit or loss is then included in total comprehensive income. 39 Chapter 1
  • 40. Gripping IFRS The Pillars of Accounting7.4.3 Other comprehensive income (IAS 1.88 and 1.90-91)Other comprehensive income includes items of income and expense that were either notrequired or were not permitted to be included in profit or loss. There are five components toother comprehensive income (as defined):• changes in a revaluation surplus;• actuarial gains and losses on defined benefit plans;• gains and losses arising from translating the financial statements of a foreign operation;• gains and losses on re-measuring available-for-sale financial assets;• the effective portion of gains and losses on hedging instruments in a cash flow hedge.The total of these five components is then included in total comprehensive income.These components may be shown in the statement of comprehensive income either:• net of tax; or• before tax, followed by one aggregate amount for the tax effect of all five components.The amount of tax for each of the five components must be disclosed. This can be giveneither in the statement of comprehensive income or in the notes.7.4.4 Expenses (IAS 1.99)7.4.4.1 OverviewAn analysis of the expenses must be provided based on either the• nature of the expenses (nature method); or• function of the expenses (function method).Choosing between the ‘nature’ and ‘function’ methods depends on which method providesreliable and more relevant information. Exactly the same profits (or losses) will result nomatter which method is used.This analysis could be included in the statement of comprehensive income or in the notes.The nature method is intended for a smaller, less sophisticated entity. The function method isdesigned for larger businesses that have the ability to allocate expenses to their functions on areasonable basis. The function method actually requires that expenses be shown in both wayssince: • the classification by function is given in the statement of comprehensive income; and • the classification by nature is given in the notes.7.4.4.2 Function method (i.e. use or purpose) (IAS 1.103)Generally, the four main functions (tasks) of a business include the sales, distribution,administration and other operations. If one uses the function method, one has to allocate theexpenses incurred to these different functions. The function method is therefore morecomprehensive than the nature method. It provides information that is more relevant, butthere is a risk that arbitrary allocations may lead to less reliable information.The ‘function method’ gives more relevant information to the user than the ‘nature method’:for instance it is possible to calculate the gross profit percentage using the function method,yet it isn’t possible if the nature method is used.Information relating to the nature of expenses is crucial information to those users attemptingto predict future cash flows, therefore, if the function method is used, information regardingthe nature of the expense (e.g. depreciation and staff costs) is also given, but this additionalclassification would have to be provided by way of a note. 40 Chapter 1
  • 41. Gripping IFRS The Pillars of AccountingAn example showing the statement of comprehensive income using the function methodfollows. The highlighted section is the part of the statement of comprehensive income thatchanges depending on whether the ‘function’ or ‘nature’ method is used.ABC LtdStatement of comprehensive incomeFor the year ended 31 December 20X2 (function method) 20X2 CRevenue XOther income XCost of sales (X)Distribution costs (X)Administration costs (X)Other costs (X)Finance costs (X)Profit before tax XTax expense (X)Profit for the period XOther comprehensive income XTotal comprehensive income X7.4.4.3 Nature method (IAS 1.102)Using this method, expenses are disclosed according to their nature and are not reallocatedamongst the various functions within the entity, for example depreciation, purchases of rawmaterials, transport costs, wages and salaries are all shown separately and are not allocated tocost of sales, distribution, administration and other operations. This method suits smallbusinesses because of its simplicity.An example of the layout using the nature method appears next. The highlighted portionshows the part of the statement of comprehensive income that changes depending on whetherthe ‘function’ or ‘nature’ method is used.ABC LtdStatement of comprehensive incomeFor the year ended 31 December 20X2 (nature method) 20X2 CRevenue XOther income XAdd/ (Less) Changes in inventories of finished goods and work-in-progress (X)Raw materials and consumables used (X)Employee benefit costs (X)Depreciation (X)Other expenses (X)Total expenses (X)Finance costs (X)Profit before tax XTax expense (X)Profit for the period XOther comprehensive income XTotal comprehensive income X 41 Chapter 1
  • 42. Gripping IFRS The Pillars of Accounting7.4.5 One statement or two statements (IAS 1.81 and 1.88)There are two alternative layouts for a statement of comprehensive income:• one statement: - a statement of comprehensive income (this is the old income statement followed on immediately by components of other comprehensive income); or• two statements: - a statement of profit and loss (this can be called an income statement if you prefer); and - a statement of comprehensive income (this would start with the total profit or loss and then include items of income and expenses that were either not required or not permitted to be recognised in profit or loss).Example 15: statement of comprehensive income: two layouts comparedThe following is an extract of the trial balance of Apple Limited at year-end. Trial Balance at 31 December 20X1 Debit Credit Revenue 1 000 000 Cost of sales 450 000 Cost of distribution 120 000 Cost of administration 80 000 Interest expense 100 000 Tax expense 70 000Other comprehensive income included one item:• C170 000 on the revaluation of a machine (net of tax).Required:Prepare the statement of comprehensive income for the year ended 31 December 20X1assuming:A Apple Limited uses the single-statement layout;B Apple Limited uses the two-statement layout.Solution to example 15A: statement of comprehensive income: single statementApple LimitedStatement of comprehensive incomeFor the year ended 31 December 20X1 20X1 20X0 C CRevenue 1 000 000 XCost of sales (450 000) (X)Distribution costs (120 000) (X)Administration costs (80 000) (X)Finance costs (100 000) (X)Profit before tax 250 000 XTax expense (70 000) (X)Profit for the year 180 000 XOther comprehensive income, net of tax:Revaluation surplus increase 170 000 (X)Total comprehensive income 350 000 X 42 Chapter 1
  • 43. Gripping IFRS The Pillars of AccountingSolution to example 15B: statement of comprehensive income: two statementsApple LimitedIncome statementFor the year ended 31 December 20X1 20X1 20X0 C CRevenue 1 000 000 XCost of sales (450 000) (X)Distribution costs (120 000) (X)Administration costs (80 000) (X)Finance costs (100 000) (X)Profit before tax 250 000 XTax expense (70 000) (X)Profit for the year 180 000 XApple LimitedStatement of comprehensive incomeFor the year ended 31 December 20X1 20X1 20X0 C CProfit for the year 180 000 XOther comprehensive income, net of tax:Revaluation surplus increase 170 000 (X)Total comprehensive income 350 000 X7.4.6 Reclassification adjustments (1.92-96)It may be necessary to recognise a gain or loss in profit or loss where this gain or loss waspreviously included in other comprehensive income.This can occur with the following three components of other comprehensive income:• gains and losses arising from translating the financial statements of a foreign operation;• gains and losses on re-measuring available-for-sale financial assets;• the effective portion of gains and losses on hedging instruments in a cash flow hedge.These adjustments do not apply to the other two components of other comprehensive income:• changes in a revaluation surplus;• actuarial gains and losses on defined benefit plans.Changes in revaluation surplus and actuarial gains and losses are recognised directly inretained earnings and never through profit and loss.It is important that any reclassification adjustment is:• included with the related component of other comprehensive income• in the same period that it is reclassified as part of profit or loss.This must happen in the same period to avoid double-counting the gain (or loss) in income.The adjustment may either be reflected in:• the statement of comprehensive income; or• the notes.Example 16: statement of comprehensive income: reclassification adjustmentsBanana Limited has financial assets that it has classified as available-for-sale. Available-for-sale financial assets are measured at fair value at the end of each year, with changes in fairvalue taken to equity (gain on available-for-sale assets account). When the assets are sold,any gain or loss is then realised and recognised as income. All the assets were:• purchased on 1 June 20X1: for C100 000 43 Chapter 1
  • 44. Gripping IFRS The Pillars of Accounting• measured at 31 December 20X1 (the year-end): at their fair value of C120 000• sold on 31 December 20X1: for C130 000.The following was extracted before any journals related to these assets had been processed: Trial balance (extracts) Debit Credit Revenue 1 000 000 Cost of sales 450 000 Cost of distribution 120 000 Cost of administration 80 000 Interest expense 100 000 Tax expense 70 000Required:A Show all the journal entries relating to the financial assets (ignore tax);B Present the statement of comprehensive income (as a single statement), with reclassification adjustments provided in this statement (not in the notes). Ignore tax.Solution to example 16A: journals1 June 20X1 Debit CreditFinancial assets Given 100 000 Bank 100 000Purchase of financial assets31 December 20X1Financial assets 20 000 Gain on available-for-sale assets (equity) 20 000Measurement of financial asset – gain recognised as othercomprehensive income (equity)Bank 130 000 Financial assets 120 000 Profit on sale of financial assets (income) 10 000Profit on sale of financial assetsGain on available-for-sale assets (equity) 20 000 Profit on sale of financial assets (income) 20 000Recognition of previous gain on financial asset (equity) as incomeSolution to example 16B: statement of comprehensive incomeBanana LimitedStatement of comprehensive incomeFor the year ended 31 December 20X1 20X1 20X0 C CRevenue 1 000 000 XCost of sales (450 000) (X)Gross profit 550 000 XOther income: profit on sale of financial assets (20 000 + 10 000) 30 000 XDistribution costs (120 000) (X)Administration costs (80 000) (X)Finance costs (100 000) (X)Profit before tax 280 000 XTax expense (70 000) (X)Profit for the year 210 000 XOther comprehensive income:Gain on available-for-sale financial asset 0 X Gains arising during the year 20 000 Less reclassification adjustment: gain now included in profit and loss (20 000)Total comprehensive income 210 000 X 44 Chapter 1
  • 45. Gripping IFRS The Pillars of Accounting7.4.7 Changes to profit or loss (IAS 1.89)IAS 8 states that there are two instances where changes to profit or loss should not berecognised in the profit or loss for the current period but should be made retrospectively.These two instances include:• a change in accounting policy; and a• a correction of a material prior period error.Any changes due to these changes will be reflected in the statement of changes in equity andshould not appear in the statement of comprehensive income.7.4.8 Disclosure: in the statement of comprehensive income (IAS 1.82-87)7.4.8.1 Disclosure: total comprehensive incomeCertain items (where applicable to the entity) in the calculation of total comprehensiveincome must be disclosed as line items in the statement of comprehensive income:• revenue *;• finance costs *;• share of profits and losses of equity-accounted associates and joint ventures *;• tax expense *;• in respect of discontinued operations, a total of the after-tax *: - profits or losses on the discontinued operation/s; and - gains or losses on the discontinued operation’s assets caused by: o the measurement to fair value less costs to sell; or o the disposal of these assets or groups of assets ;• profit or loss *;• each component of other comprehensive income (classified by nature);• share of other comprehensive income of equity-accounted associates and joint ventures;• total comprehensive income.Each item above that has been marked with the asterisk (*) would be included in thestatement of profit or loss if the ‘two-statement approach’ was used.Further disclosure is required of any additional line item that is considered to be relevant tothe understanding of the entity’s financial performance.No item may be classified as extraordinary.7.4.8.2 Disclosure: allocations of total comprehensive incomeIf an entity is part of a group where it is wholly owned by another company (the parentcompany), then 100% of the total comprehensive income would belong to this parentcompany. If, however, this parent company does not own 100% of the entity, but only a partthereof, then only that portion of the total comprehensive income would belong to the parentand the balance would belong to ‘the other owners’ (minority interests).Where the comprehensive income is shared between a parent company and other minorityowners, then the allocation between these two categories of owners must be disclosed in thestatement of comprehensive income:• the portion of the profit or loss that is attributable to the *: - owners of the parent; - minority interest; and• the portion of total comprehensive income that is attributable to the: - owners of the parent; - minority interest. 45 Chapter 1
  • 46. Gripping IFRS The Pillars of Accounting*: the allocation of profit or loss can be given in the statement of profit or loss where this hasbeen provided as a separate statement (i.e. if a two-statement approach had been used).7.4.9 Disclosure: either in the statement of comprehensive income or the notesIn addition to disclosing the aggregate ‘profit or loss’ as a separate line item on the face of thestatement of comprehensive income, certain of the income and expenses making up thisamount may be material enough to require separate disclosure (either as separate line items inthe statement of comprehensive income or in the notes), in which case their nature andamount must be disclosed. Examples of some material items (given in IAS 1) include:• write-downs of assets and reversals thereof;• restructuring costs and the reversal of provisions for costs of restructuring;• disposals of property, plant and equipment and investments;• discontinued operations;• income and expenses relating to litigation settlements; and• reversals of any other provisions7.4.10 A typical statement of comprehensive income7.4.10.1 Sample statement of comprehensive income for a simplified, single entityThis is an example of a statement of comprehensive income that might apply to a singleentity. It has also been simplified to show a very basic statement where there are noassociates or discontinued operations.Please remember that the line items in your statement of comprehensive income might befewer or more than those shown below. It depends entirely on what line-items are relevant tothe entity (e.g. if the entity does not have available-for-sale assets, then one of thecomponents of other comprehensive income would fall away).ABC LtdStatement of comprehensive incomeFor the year ended 31 December 20X2 (function method) 20X2 20X1 C CRevenue X XOther income X XCost of sales (X) (X)Distribution costs (X) (X)Administration costs (X) (X)Other costs (X) (X)Finance costs (X) (X)Profit (or loss) before tax X XTaxation (X) (X)Profit (or loss) for the year X XOther comprehensive income X X• Gain on available-for-sale financial assets X X• Increase in revaluation surplus X XTotal comprehensive income X X 46 Chapter 1
  • 47. Gripping IFRS The Pillars of Accounting7.4.10.2 Sample statement of comprehensive income for a group of entitiesThis example relates to a group of entities. When there is a group of entities, there needs tobe a section that allocates profit and total comprehensive income between the:• owners of the parent; and• minority interests.This example also includes more line-items that the first simplified example of a statement ofcomprehensive income: it now includes an associate and a discontinued operation.ABC LtdConsolidated statement of comprehensive incomeFor the year ended 31 December 20X2 (function) 20X2 20X1 C CRevenue X XOther income X XCost of sales (X) (X)Distribution costs (X) (X)Administration costs (X) (X)Other costs (X) (X)Finance costs (X) (X)Profit (or loss) before tax X XTaxation (X) (X)Profit (or loss) for the year X XOther comprehensive income X X• Gain on available-for-sale financial assets X X• Increase in revaluation surplus X XTotal comprehensive income X XProfit for the year attributable to: X X- owners of the parent X X- minority interest X XTotal comprehensive income for the year attributable to: X X- owners of the parent X X- minority interest X X7.5 The statement of changes in equity7.5.1 OverviewA change in equity is simply the increase or decrease in the net assets of the entity (or referredto as a change in position). Such a change is represented by one or more of the following:• transactions with owners; and• total comprehensive income.Components of equity include:• each class of contributed equity (e.g. ordinary shares and preference shares);• retained earnings;• five possible classes of comprehensive income: - (1) revaluation surplus; (2) gains and losses on available-for-sale financial assets; (3) actuarial gains and losses on defined benefit plans; (4) gains and losses on effective cash flow hedges; and (5) gains and losses on translation of foreign operations. 47 Chapter 1
  • 48. Gripping IFRS The Pillars of Accounting7.5.2 Disclosure: in the statement of changes in equity (IAS 1.106-110)The following must be disclosed in the statement of changes in equity:• for each component of equity: - the effect of any change in accounting policy; - the effect of any correction of error; and - a detailed reconciliation between opening and closing balances for the period;• total comprehensive income for the period;• the transactions with owners in their capacity as owners, showing separately: - contributions by owners; and - distributions to owners.If there has been a change in accounting policy or a correction of error, the effect of theadjustment or restatement on the balances must be disclosed:• for each prior period; and• the beginning of the current period.If the financial statements are being prepared for a group of companies (as opposed to asingle company), then disclosure must also include the allocation of total comprehensiveincome to:• owners of the parent; and• minority interests.7.5.3 Disclosure: either in the statement of changes in equity or notes (IAS 1.107; 1.137)Dividends recognised during the year need to be disclosed• in total; and• per share.A dividend distribution normally follows the following life-cycle:• proposal; then• declaration; then• paymentDividends are first proposed in a meeting. If the proposal is accepted, the entity will declarethe dividend. According to IAS 10 (paragraph 13), a declared dividend is a dividend that isappropriately authorised and no longer at the discretion of the entity. Declaring a dividendmeans publicly announcing that the dividend will be paid on a specific date in the future. It isonly when the declaration is made, that the entity effectively creates an obligation to pay thedividend. It is therefore only on the date of declaration that a journal is passed to recognisethe liability to pay dividends (no journal is processed when the dividend is proposed): Debit CreditDividends declared (distribution of equity) Xxx Dividends payable (liability) XxxDividend declaredRemember that a dividend declared is not recognised as an expense but rather as a distributionof equity because it does not meet the definition of an expense (read this definition again).Some dividends are not recognised as distributions to equity holders since there is noobligation to pay them at the end of the reporting period. These include dividends that are:• proposed before or after the reporting date but are not yet declared or paid; and• declared after reporting date but before the financial statements are authorised for issue.The total of the above dividends that have not been recognised must be disclosed in the notes:• in total; and• per share. 48 Chapter 1
  • 49. Gripping IFRS The Pillars of AccountingThe amount of any cumulative preference dividends that, for some reason, have not beenrecognised must also be disclosed in the notes.7.5.4 A typical statement of changes in equity7.5.4.1 Sample statement of changes in equity for a simplified, single entityThis example shows a statement of changes that might apply to a single entity. Thisstatement of changes in equity has been further simplified to show a very basic spread ofequity types (i.e. it does not have reserves other than retained earnings and has only one typeof share capital: ordinary shares).ABC LtdStatement of changes in equityFor the year ended 31 December 20X2 Share Share Retained Total capital premium earnings equity C C C CBalance: 1 January 20X1 - restated X X X XBalance: 1 January 20X1: as previously reported XChange in accounting policy XCorrection of error XTotal comprehensive income XLess dividends declared (X)Add issue of shares X XBalance: 31 December 20X1 - restated X X X XBalance: 31 December 20X2: as previously reported XChange in accounting policy XCorrection of error XTotal comprehensive income XLess dividends declared (X)Add issue of shares X XBalance: 31 December 20X2 X X X X7.5.4.2 Sample statement of changes in equity for a group of entitiesThis example of a statement of changes in equity shows one for a group of entities. If thestatement of comprehensive income shows a group of entities, there needs to be extracolumns to show the allocation of total equity between the:• owners of the parent; and• minority interests.This example also includes more columns that the first simplified example of a statement ofcomprehensive income: it now includes a translation reserve, available for sale reserve and arevaluation surplus.The columns in the statement of changes in equity for your entity might be fewer or morethan those shown in the examples. It depends on:• what columns are relevant to the entity (e.g. if the entity does not have foreign operations, then a translation reserve would not be necessary); and• the materiality of the reserves.Some other equity accounts that you may find that would require separate columns include:• capital accounts: stated capital and preference share capital;• statutory reserve: capital redemption reserve fund;• non-distributable reserve: revaluation reserve (surplus) or asset replacement reserve; and• cash flow hedge reserves (of effective portion of gains and losses)• general reserves. 49 Chapter 1
  • 50. Gripping IFRS The Pillars of AccountingABC LtdConsolidated statement of changes in equityFor the year ended 31 December 20X2 Attributable to owners of the parent Minority Total Share Available Trans- Reval- Retained Total interest equity capital for sale lation uation earnings equity assets reserve surplus C C C C C C C CBalance: 1 Jan 20X1 - X X X (X) X X X XrestatedBalance: 1 Jan 20X1 - as Xpreviously reportedChange in acc. policy (X)Total comprehensive X X X X X X XincomeLess dividends (X) (X) (X) (X)Add share issue X X X XBalance: 31 Dec 20X1 - X X X (X) X X X XrestatedBalance: 31 Dec 20X1 - Xas previously reportedChange in accounting (X)policyTotal comprehensive (X) X (X) X X X XincomeTransfer to retained (X) XearningsLess dividends (X) (X) (X) (X)Add share issue X X X XBalance: 31 Dec 20X2 X X X (X) X X X X7.5.4.3 Exam techniqueThe total comprehensive income in the statement of comprehensive income is equal to thetotal comprehensive income shown on the face of the statement of changes in equity. If youare required to present both a statement of comprehensive income and a statement of changesin equity, then good exam technique would be to start with the statement of comprehensiveincome and then, when preparing your statement of changes in equity, put the totalcomprehensive income per your statement of comprehensive income into your statement ofchanges in equity.7.6 The statement of cash flows (IAS 1.111)7.6.1 OverviewThe statement of cash flows gives information regarding the entity’s cash flow broken downinto the three main areas of activity, namely:• operating activities;• investing activities; and• financing activities.This statement is useful in assessing the ability of the entity to generate cash and cashequivalents and the company’s related need for cash.A separate standard (IAS 7) covers this component in detail and therefore the ‘statement ofcash flows’ is covered in its very own chapter. 50 Chapter 1
  • 51. Gripping IFRS The Pillars of Accounting7.7 The notes to the financial statements (IAS 1.112-124)7.7.1 OverviewNotes give additional information about:• items that are included in the other four statements; and• items that are not included in the other four statements yet which, for one reason or another, do require separate disclosure;• whether the financial statements comply with all IFRSs;• basis of preparation and the significant accounting policies;• measurement bases;• sources of estimation uncertainty;• how the entity manages its capital (i.e. what are its objectives, policies and processes in this regard).7.7.2 Structure of the notes (IAS 1.112-117 and IAS 1.122)The notes must be presented in a systematic and logical manner. The other four statementsmaking up the financial statements must be cross-referenced to the notes. Notes supportingitems in the other four components should be listed in the same order that each line item andeach financial statement is presented (on occasion, a note may refer to more than one lineitem, in which case one must simply try to be as systematic as possible).The following order or structure is normally followed:• statement of compliance with International Financial Reporting Standards;• a summary of significant accounting policies used including: - a statement of the measurement basis (or bases) used in preparing the financial statements (e.g. historical cost, fair value etcetera); and - the accounting policies used that would help to understand the financial statements; - the judgements that management made in applying its accounting policies that had the most significant effect on amounts recognised in the financial statements; - this summary can be presented as a separate statement in the financial statements, with the result that there would be six statements making up the financial statements;• supporting information for items included in the other four components that: − must be separately disclosed according to IFRS and/or the statutory requirements (e.g. the different classes of inventory making up the balance in the statement of financial position); − must be separately disclosed in order to improve understanding; and• information regarding other items that are not included in the other four components that: − must be separately disclosed according to IFRS and/or the statutory requirements (e.g. contingent liabilities; commitments and details of events that happened after the reporting date but before the financial statements were authorised for issue); − non-financial disclosures (e.g. the entities objectives and policies regarding its financial risk management); and − judgements that management has made that have had the most significant effect on the amounts in the financial statements (these can be presented as part of the accounting policy note instead of as a separate note on significant judgements).7.7.3 Disclosure of accounting policies (IAS 1.117 – 124 and 125)7.7.3.1 OverviewThe summary of significant accounting policies would include:• The measurement basis or bases used in preparing the financial statements, for example: - Historical cost - Current cost - Net realisable value - Fair values - Recoverable amounts; and 51 Chapter 1
  • 52. Gripping IFRS The Pillars of Accounting• Other accounting polices that would help users understand the financial statements; and• Judgements that management has had to make in applying accounting policies, example: - whether the entity’s financial assets should be classified as available-for-sale or held- to maturity etc (each classification would be measured differently); - whether certain sales are actually disguised financing arrangements, which would then not result in revenue; and• Judgements that management make regarding the future and estimation of amounts: source of estimation uncertainty.7.7.3.2 Significant and relevantOnly the accounting policies that are significant to an entity need to be disclosed. Accountingpolicies may be considered significant even if the amounts related thereto are immaterial.When deciding whether or not to disclose an accounting policy, one should consider whetheror not it would assist the user in understanding the performance and position of the entity.Here are a few examples of accounting policies that may be relevant to an entity:• whether property, plant and equipment is measured at fair value less subsequent depreciation or historical cost less depreciation and what rates of depreciation are used;• the fact that deferred tax is recognised and measured using the comprehensive basis and whether deferred tax assets are recognised;• when revenue is recognised and how it is measured; and• any accounting policy devised by management in the absence of an IFRS requirement.Whether an accounting policy is relevant to an entity depends largely on the nature of itsoperations. For example, if an entity is not taxed, then including accounting policies relatingto tax and deferred tax would be a silly idea!7.7.3.3 Judgements made by managementThe standard refers to two types of judgements made by management:• Judgements made by management in deciding which accounting policies to apply;• Judgements made by management in making estimates: sources of estimation uncertainty.Judgements made by management in the application of accounting policies (i.e. other thanthose involving actual estimations) that have had a significant effect on the amountsrecognised in the financial statements should be disclosed. An example of such a judgementwould be when management decides that one of the buildings owned is ‘held for sale’ (i.e. not‘held for use’) with the result that IAS 40: Investment property is used to account for thatbuilding instead of IAS 16: Property, plant and equipment. These judgements may bedisclosed either with the list of significant accounting policies or as a separate note.Judgements made by management in making actual estimates are referred to as sources ofestimation uncertainty. Making estimates requires a subjective assessment of many things,including the future – a difficult task indeed! For this reason, information about thesejudgements is typically included as a separate note (i.e. not in the summary of significantaccounting policies). Sources of estimation uncertainty are discussed below in more depth.7.7.4 Sources of estimation uncertainty (IAS 1.125 – 133)Drawing up financial statements involves many estimates. These estimates involveprofessional judgements, from the decision regarding depreciation rates to the assessment ofthe entity to continue as a going concern. These estimates involve both an assessment ofsources of uncertainty at reporting date and in the future. Where an assumption has beenmade regarding uncertainties (e.g. the life of an asset, future selling prices, future costs, futureinterest rates), that involve a high degree of subjective and complex ‘guesswork’, there is, ofcourse, a risk of being ‘wrong.’ 52 Chapter 1
  • 53. Gripping IFRS The Pillars of AccountingDisclosure is required when this possibility of being wrong amounts to:• a significant risk• that a material adjustment to the carrying amount of an asset or liability• may need to be made within the next financial year.The disclosure would need to include:• the nature and carrying amount of the assets and liabilities affected;• nature of the assumption or estimation uncertainty;• sensitivity of the carrying amounts to the methods, assumptions and estimates used in their calculation;• reasons for the sensitivity;• range of reasonably possible carrying amounts within the next financial year; and• changes made (if any) to past assumptions if the uncertainty still exists.If an asset or liability is measured at fair value based on market prices, and there is asignificant risk of its carrying amount changing materially within the next year, no disclosureis required since the change in its carrying amount is caused by the market price changing andis not caused by incorrect assumptions made by management.Example 17: sources of estimation uncertaintyWeezy Limited is a petrochemical company that has a bad reputation for environmentalpollution. It has recently been presented with numerous legal claims from residents in thesurrounding neighbourhood.Required:Explain the issues that Weezy Limited must consider when complying with IAS 1requirement’s regarding ‘sources of estimation uncertainty’.Solution to example 17: sources of estimation uncertaintyThere are two areas of concern for Weezy Limited where assumptions made by management involve ahigh degree of risk that a material adjustment to an asset or liability may be required in the next year.In this regard, management must decide:• Recognition and measurement: whether it must make provisions for restoration of the environment due to the impact of pollution possibly caused by it. This will require assumptions regarding the amounts and timings of the likely cash flows.• Disclosure: what to disclose regarding the likely outcome, amounts of damage probable and the timing of such payments pursuant to the recent legal claims received.7.7.5 Capital management (IAS 1.134-135)An entity must disclose its objectives, policies and processes for managing its capital. In sodoing, the disclosure must include:• qualitative information regarding the objectives, policies and processes for managing its capital, including at least the following information: - a description of what it considers to be capital; - the nature of any externally imposed capital requirements - how externally imposed capital requirements (if any) have been incorporated into the entity’s management of capital - how it is meeting its objectives for managing capital;• quantitative information regarding what it considers to be capital (since the term capital is not defined): - some entities include some financial liabilities when talking about their capital (e.g. the entity may manage its subordinated debt as part of its capital); while - some entities exclude certain equity accounts from their idea of capital (e.g. the entity may not consider its cash flow hedge reserves to be part of capital);• changes to the information provided above from the prior year; 53 Chapter 1
  • 54. Gripping IFRS The Pillars of Accounting• whether it complied with the externally imposed capital requirements (if applicable) during the period; and• the consequences of non-compliance with externally imposed capital requirements (if applicable).7.7.6 Other disclosure required in the notes (IAS 1.137-138)Other information requiring disclosure includes:• the domicile and legal form of the entity;• which country it was incorporated in;• the address of its registered office or principal place of business;• a description of the nature of the entity’s operations and principal activities; and• the name of the parent entity and the ultimate parent of the group (where applicable).The notes must also include the following information relating to unrecognised dividends:• the amount of any dividend proposed before the financial statements were authorised for issue and the dividend per share;• the amount of any dividend declared before the financial statements were authorised for issue and the dividend per share; and• the amount of any cumulative preferences dividends not recognised. 54 Chapter 1
  • 55. Gripping IFRS The Pillars of Accounting 8. Summary The Pillars Framework IAS 1Framework for the preparation and presentation Presentation of financial statements of financial statements• objectives of financial statements • objective of IAS 1• underlying assumptions • objective of financial statements• qualitative characteristics • the 5 statements in a set of fin.• the elements statements• recognition of the elements • the 8 general features• measurement of the elements • the structure & content of fin. statementsObjective of Underlying Qualitative Recognition & Generalf/statements assumptions characteristics measurement features- providing info - accrual basis - understandability Recognition: - fair about the: - going concern - relevance - meet presentation & financial - reliability definition compliance with position, - comparability. - meet IFRS; perform. & recognition - going concern; cash flows criteria - accrual basis;- that is useful - materiality and to a aggregation; Measurement: wide range of - offsetting; - historical cost users in - reporting - current cost making eco. frequency; decisions; and - present values - comparative- showing the - fair values information; results of - liquidation - consistency. mgmt’s values stewardship - etc of the resources entrusted to it. 55 Chapter 1
  • 56. Gripping IFRS The Pillars of Accounting The financial statements comprise:Statement Statement of Statement of Statement Notes toof financial changes in comprehensive of cash the fin. position equity income flows statementsFinancial Changes in Financial Cash generating Basis ofposition: financial performance: ability: preparation;assets, position: income and Cash Accountingliabilities movement in expenses movements policies;and equity equity (issued analysed into: Information capital and • operating not disclosed reserves) • investing in other Detail given for and statements transactions • financing that need to with owners activities be disclosed Elements in the financial statements Assets Liabilities• Resource • Present obligation• Controlled by the entity • Of the entity• As a result of a past event • As a result of a past event• From which future economic benefits • From which future economic benefits are are expected to flow to the entity expected to flow from the entity Equity • Assets less • Liabilities Income Expenses• An increase in economic benefits • A decrease in economic benefits• During the accounting period • During the accounting period• In the form of increases in assets or • In the form of decreases in assets or decreases in liabilities increases in liabilities• Resulting in increases in equity • Resulting in decreases in equity• Other than contributions from equity • Other than distributions to equity participants participants 56 Chapter 1
  • 57. Gripping IFRS The Pillars of Accounting Recognition of elements Asset and liability Income and expense• Future economic benefits probable • Reliably measurable• Reliably measurable Recognition criteria met? Yes No• Recognise; and where applicable Is the item material to the user?• Disclose separately (if required by a IFRS or if it is considered necessary for fair presentation) Yes No Disclose Ignore 57 Chapter 1